Today's Idea

A quick look at the daily chart for May Cotton shows solid resistance just below the 100.00 level. Given the bearish fundamentals and fairly strong technical resistance, some traders may wish to explore selling out-of-the-money calls in Cotton futures options with a strike price above the 100.00 resistance level. For example, with May Cotton trading at 93.38 as of this writing, the May 101 calls could be sold for 1.10, or $550 per option, not including commissions. The premium received would be the maximum potential gain on the trade, which would be realized at option expiration in April should the May futures be trading below 101.00.

Fundamentals

The days of $2 plus Cotton prices may be nothing but a distant memory for traders, as lackluster demand and rising global supplies may keep rally attempts in check this year. Despite the sharp drop in Cotton prices from last year, historically 90-cent plus new-crop is rather attractive and may convince some more marginal producers to still plant Cotton -- especially in the drought stricken southwestern portions of the U.S. Even if U.S. Cotton acreage is cut somewhat, it appears that U.S. production could rise this coming year, especially if weather conditions improve this coming spring and summer. Record high prices in 2011 also encouraged a surge in global Cotton production, increasing competition for U.S. exports and allowing global ending stocks to rise to an estimated 61 million bales. The wildcard for Cotton demand continues to be China, which is the world's largest consumer of Cotton. China was a strong buyer of Cotton in 2011, but signs of a moderate economic slowdown in the world's most populous nation may slow Chinese demand this coming season and put further pressure on prices. Traders will get their first glimpse at estimated U.S. Cotton production for 2012 when the USDA releases its highly anticipated Prospective Plantings report on March 30th.

Technical Notes

Looking at the daily chart for May Cotton, we notice the uptrend line drawn from the December lows has been firmly taken out on the downside, which may be the start of the next downward leg of the bear trend. Prices are now holding below both the 20 and 200-day moving average, and momentum as measured by the 14-day RSI has turned lower, with a current reading of 45.35. The moderate price rally the past couple of trading sessions might be the start of a "bear flag" formation and, if so, we likely should see prices hold below the nearest resistance level, which is currently the 20-day moving average at 95.43. Support is found at the February 10th low of 91.62.



Mike Zarembski, Senior Commodity Analyst

This article appears as part of a content sharing arrangement with optionsXpress.

Free Practice Trading at optionsXpress