Posted January 31, 2005

Buy Cotton

In late 2001, partially due to worldwide economic weakness, Cotton hit what I consider to be a once-a-decade low at 29 cents a pound. Two years later it had rallied over 50 cents (one cent = $500 per futures contract) to make an October 2003 high at 85 cents. It then reversed sharply and fifteen months later has dropped over 40 cents to its current level around 43 cents a pound......The point?...COTTON MOVES.....Not only has it done so for the past three years, but from the 30 year chart just below, you will easily note this sort of movement has been the norm for a long time....I don't expect this to change.

This is only the fourth time in 30 years that Cotton has been at current levels.... We are buying it, using futures and options in the July, 2005 contract and are expecting a move at least to the mid 60 cent area before the July contract expires.

Some reasons....

During the past 30 years, there have been only three years in which July Cotton has expired below today's 46.20 cents per pound price (see table below).....Two of those years were about 1 1/2 cents lower, while the 2001 worldwide economic slowdown produced the lowest close of a July contract in 30 years....at 41.48 being about 4.75 cents below where July is today.

                Expiration Price of July Cotton for the Last 30 Years
                               Compare to today's close of 46.20

With the world firmly in an economic upswing, particularly in China which produces over 50% of the world's textile exports, and this year's crop size now a known (and therefore probably factored into the market), I think the chances of July Cotton expiring lower than its current prices are quite low.

Again, COTTON DOES MOVE....On the next table are the total ranges for every July Cotton contract, for the past 30 years,  between January 31st and the expiration of the contract in July...By total range, I refer to how much of a swing there is between the lowest trade and the highest trade of July Cotton...Note that in the past 30 years there is only one year in which that range was less than 10 cents....

Total Range July Cotton in Cents Per Pound - January 31st to Expiration

This is my case....

1. Assuming Cotton "matches" its historical movement for the past 30 years (the average is about a 20 cent range), how much room is there for it do so on the downside?

2. When taking into account it has only expired three times below its current price during these same 30 years (again, the worse case having been only about 4 3/4 cents lower), is buying Cotton here a good idea?

3. This year's crop is not even in the ground yet. With prices as low as they are, how much cotton will be planted world wide (or not planted) is still an unknown.

4. As always, weather is an unknown for this year's growing season. Whether it be too little rain, too much rain, or hurricanes...get any of them and it is generally very bullish for cotton prices.

5. Cotton is not a marginal use commodity. What is out there will get used, especially when this raw material can be purchased today (and then fabricated) for 1/2 the price it was just 15 months ago.

I don't know for sure that Cotton is going up.  I may be dead wrong and an investment in this idea may result in your losing money, but considering the inherent volatily of this market, I believe buying Cotton at these prices represents about as good a bet as you ever get in this business.

Using today's close, here is our basic recommended "unit".

Buy 2 July 48 calls @ 2.42   =  $2520
Buy 1 July 46 put @ 3.00     =   1585
Total (includes commission)       $4105

There are innumerable permutations as to how this trade can develop but here are some basics:

If July goes to 60 cents the 2 calls would be worth $12,000.
If July stays between 46 and 48 cents, you will lose the entire investment.
If July goes to 38 cents, by selling the put, you should be able to recoup 100% of your investment.

We will use tomorrow's opening as our formal recommendation entry prices for this unit (posted 2/1/05 - Bought 2 July Cotton 48 calls @ 2.50 and 1 July Cotton 46 put @ 2.90).

There are obviously other ways to do this, using futures with puts as defense for example, or for the reckless at heart, just buying the calls.

I may be dead wrong but I think this is a great, great trade....

Give me a call if you want to talk about it....

Thanks,
Bill Rhyne

800-578-1001
770-514-1993