From the Train the Trainer Handbook:

Successful operators are sharpening their skills in marketing. Although producers do not individually control price, they do control when and how to price. Price movements in cotton/rice carry a great deal of uncertainty because of changes in weather and resulting yields, in foreign and domestic policies, in government and trade policies, and in supply/demand forces.

Plan to Manage Price Risk
Market-oriented prices are volatile. And, U.S. farm programs have considerable support towards less government influence and more market direction. Season average cotton prices prior to government programs varied by about 75 percent from season-to-season.

It is clear that the financial stakes are high in developing a sound plan to deal with fluctuating prices. A marketing plan requires a logical approach in deciding at what price to sell or buy and by what method to establish that price. While the pricing decision is not easy, it may be extremely rewarding. The decision requires an informed understanding of how and why prices move up and down. Knowing the basics of supply and demand are necessary. But, also understanding the technical signals helps in timing pricing decisions. In the short run, traders tend to follow the technical signals.

Marketing Plan Essential
A marketing plan is an essential step in effectively managing price risk. A plan includes evaluation of the financial position of your business, risk-taking philosophy, timing of cash flow, estimated breakeven cost, and a realistic profit margin based on selected pricing strategies. A computer is helpful in calculating expected income for each crop. Then use tables and charts to set total levels of income needed to cover cash and total expenses and an acceptable income for the operation.

Financial position of business helps determine the risk that can be absorbed without encountering severe financial problems. Start with a financial statement and then calculate debt-equity ratios based on short-, intermediate-, and long-term debt. A review of repayment history and repayment capacity puts debt-equity ratios into perspective. The attitude toward risk should be considered for all individuals with a financial stake in the business.

Another consideration is the timing of sales to meet cash flow needs. Payment of expenses influences the pricing method chosen. Income from pricing strategies that pay at harvest is usually preferable to storage.

The estimation of costs and returns is critical to the economic health of the business. If you have trouble showing profit on paper, it is important to consider relevant alternatives before financial obstacles become too big to overcome.

Estimate Expected Costs, Returns and Risk
Knowing your production costs for each alternative enterprise will be a key to survival under the 1996 Farm Bill. Costs fall into two main categories variable (cash) and fixed (overhead). The business must cover variable and fixed expenses in the long run. Breakeven costs are greatly influenced by yields. Therefore, a range in estimated yields may provide a more realistic perspective on income and risk exposure. Records should indicate production costs for past years.

Risk of recovering cash expenses from crop sales per alternative crop is much more important when there is no viable government safety net on income. Yield and income insurance for each crop needs to be carefully evaluated. Expected returns per acre may favor cotton over corn, sorghum, wheat, and soybeans. But, when risk per dollar of expenses is considered, cotton, rice, and sorghum returns as a percentage of cash expenses tends to be far less than returns for wheat, corn, and soybeans. Returns over cash expenses for alternative enterprises need to be compared with returns above all expenses to gain an understanding of risk exposure to the business.

Develop Market Expectations
Develop market expectations from reliable outlook information. It is desirable to gather outlook perspectives from several sources to compare market views. Develop your own skills as to evaluating and interpreting price expectations that is even if you use a market advisor or marketing group. Learn to watch for signals that indicate price changes. You can gain a better understanding of markets by reviewing historical charts on futures and cash price movements relative to supply and demand relationships. Knowing the expected difference between local cash and futures prices (basis) helps to estimate your price.

Market forces involve ongoing changes. Therefore, you should update market expectations often. Organizing a marketing club or joining an existing club is a good way to learn more about markets and to keep informed.

Market Guidelines
First of all, recognize that the price at harvest will likely be substantially different than at planting time. Most of the time it will be lower. Seasonal price variations exist and vary according to the overall supply/demand balance. In short crop years, prices tend to peak early both for crop just harvested as well as forward prices for next crop. In years when crop supply is abundant, prices tend to be weak early and strengthen toward mid-year. Also, in short crop years, prices are more erratic.

Stay abreast of market forces and be ready to adjust price objectives. Avoid round number price objectives such as 80 or 85 cents per pound cotton. For example, December 96 futures never reached 85 cents but slipped slightly above 84 cents. Be careful in pricing near report release dates. Markets are jumpy near these times. Overall, consider downside price risk versus topside price potential.

Implement Your Plan
Markets are not going to give you anything if you do not take action to implement your marketing plan. Price a part of he crop if a realistic price level exists. Don t wait too long to start. Don t try to pick the market peak. The peak is only known after it happens. Space pricing over time and at levels hopefully above costs. Try to use scale up pricing during market rallies. Be prepared to take advantage of short-term price rallies. Learn the key technical signals and use moving averages to help identify price trends.

If you consider storage and holding and hoping or a higher price , calculate storage costs and compare them to buying a July call option. July futures usually are weakest in November.

Discipline to follow a year-round marketing plan helps to overcome the emotions of fear, greed and panic. You must take pricing opportunities when the market moves in your favor.

Price for Profit
Marketing plans and year-round strategies of pricing provide opportunities to increase income and to obtain needed inancing. It is important to estimate your per pound cost of producing cotton or rice. In the short-run, price must cover cash costs; but, in the longer run, price must cover all cash and fixed or overhead costs. If your total production costs per pound are over 75 cents for cotton, you need to review your costs for efficiency. Growers planting cotton on the more productive soils report production costs in the 60 to 70 cent per pound range. Set aside a few minutes a day or a week for studying markets and charting daily prices to learn about market forces behind the price movements.

Cotton pricing problems stem largely from fluctuating prices. Cash farm prices are linked to the futures market. As prices move up and down, the futures and options markets offer a wide selection of pricing opportunities. There are several pricing alternatives available to use in setting a price when the market is right for your business. Forward cash contracts, options, futures, or a combination of these alternatives are all viable pricing considerations.

Market price changes are mixed and follow no easily predictable pattern over time. However, looking at daily December cotton futures since 1980, the highest price has been reached 13 times out of 16 between May and September. But, 7 of the 13 highs have been in the year prior to harvest. Of the early highs, five preceded crops where supplies increased substantially.

$75 to $90 Per Bale Price Swings
Since the December 1988 futures contract came on the board, the price swing from low to high per contract has averaged near 18.0 cents per pound over 10 years (table 1). But, since 1993 the price change has averaged slightly less at 16.1 cents per pound. Following the cotton marketing loan, the largest price move came when the 1987 contract skyrocketed from a low of 34.4 cents in July 1986 to a settlement high of 79.8 cents in August 1987.

By contrast, the smallest move was 9.5 cents per pound for December 1993 futures. Of the December contracts, the highest price was 97 cents in September 1980; the lowest 30.2 cents in July 1986. In the last 10 years, the high has averaged 77.4 cents and the low 59.5 cents. This suggests that December futures tend to trade much of the time in the 60 to 75 cent range. The futures contracts trading periods have now been expanded to 24 months from 18 months in order to fully span two crop seasons.

Buyers and sellers who have developed effective marketing skills have various opportunities to either buy low and/or sell high. Price highs have exceeded 76 cents 12 of the 17 years that ended in 1996, and only December 1986 topped out at 59.3 cents. Price lows dipped to the 56 to 66 cent range ten times, with two contracts hitting lows of 30 and 34 cents. And, four contracts fell in the 48 to 51 cent range.

Cotton Options Offer Pricing Flexibility
Cotton futures and options markets offer the flexibility to custom build a selling or buying program. Producers, merchants, and mill operators can design a program, spread over time, to manage ownership transfers and forward deliveries at favorable price levels.

Options may be used alone, with forward contracts, and with futures. Options, depending on pricing goals, are extremely flexible. They can be purchased, granted, or used in combination with contracts and futures to develop pricing strategies that fit the needs of users.

The purchase of options protects against adverse price moves and allows participating in favorable price rallies without margin deposits. Looked upon as price insurance , options premiums can be added to other production and marketing expenses in setting a price objective. A big plus for hedging with put options for a producer is that if price increases, additional profits can be enjoyed.

Markets are not going to give you anything.
You have to take pricing opportunities from the market.

Pricing Alternatives
The main pricing alternatives involve cash, storage, forward cash contracts, hedging with futures and options, and cooperative/group marketing. In some areas, cooperative/group marketing pools dominate the forward pricing alternatives. There are a number of other strategies and combinations that may be used.

With cash sales at harvest and storage, you have little control over your price risk and cash flow. Forward pricing strategies provide the producer several alternatives to set a price floor and reasonable control over price risk. Prepare a plan that will minimize risk but also allows you to benefit from price increases. Put options and minimum price contracts provide this type of protection. Early in the year you have more opportunities to price on an uptrend. Uncertainty of acreage, yields and foreign markets can make price changes in the fall unpredictable.

Extension programs serve people of all ages regardless of socioeconomic level, race, color, sex, religion, disability, or national origin.

The Texas A&M University System, U.S. Department of Agriculture, and the County Commissioners Courts of Texas Cooperating

1. Buying Put for 1997 Crop:

Estimated Cents/lb, Your Estimate, Jan. - Aug. 1997
Buy Dec. 97, 78 put -3.75
Basis (cash - futures) -5.00
Net* 69.25

Downside price move covered, upside open
*Broker Commissions Omitted

Buying a put offers price insurance for the cost of a premium based on the strike price and time of futures contract selected. The main advantages are no margin deposits required when purchasing options and you can benefit from a price increase. You could purchase a put and then later on if cash contracts were favorable, contract some or all of cotton. The cash forward contract protects against price decrease and locks in the basis. However, it also insulates the producer from benefits of a price increase.

In this example, a put premium of 3.75 cents and a basis of 5.00 cents adds up to an expected net of 69.25 cents.

2. Contract Cotton - Buy Call for 1997 Crop

Estimated Cents/lb
Your Estimate, Jan. - Aug. 1997, Forward Contract
(Dec. 78, -5 cents basis) 73.00
Buy Dec. 97, 78 call -4.00
Net*
69.00

Downside price move covered, upside open.
*Broker Commissions Omitted

In effect, contracting cotton and buying a call is a minimum price contract. A price floor has been set, but if futures price rises above the selected strike price and it is offset or exercised at the higher price, then a gain can be realized from the call. Forward contract for, say, 73.00 cents and buy a December call for a premium of 4.00 cents. The minimum expected price is 69.00 with the potential to benefit from a higher price.

3. Short Futures - Buy Call for 1997 Crop

Estimated Cents/lb
Your Estimate
Jan. - Aug. 1997
Short Dec. 97 Futures 78.00
Basis -5.00
Buy Dec. 97, 78 Call -4.00
Net* 69.00

Downside covered
Upside protected from margin costs
Margin deposit required, plus possible margin calls

*Broker Commissions Omitted

Selling (short) the futures and purchasing a call options will protect from a price drop with the short futures. The call option would assist in offsetting margin requirements should the price increase. The call strike price relative to futures position determines the amount of margin coverage. This strategy if left intact will insulate the price level from both an increase or decrease less the cost of the option premium. However, the call might be offset at the time the upside potential has diminished somewhat. Also, the call could be bought for a shorter time period.

4. Short (Sell) Futures for 1997 Crop

Estimated Cents/lb
Your Estimate Jan. - Aug. 1997
Short Dec. 97 Futures 78.00
Basis -5.00
Net* 73.00

Margin deposit, plus possible margin calls

*Broker Commissions Omitted

Taking a sell (short) position on the futures establishes a price subject to basis variation. If price goes up, margin deposits must be made, but cash market will offset if cash relationship to futures price stays as expected. Short December 97 at 78.00 cents with expected 5.00 cent basis establishes an expected 73.00 cent price. Basis may vary depending on market conditions.

5. Buy Put - Sell Call for 1997 Crop window

Estimated Cents/lb
Your Estimate, Jan. - Aug. 1997
Buy Dec. 97, 78 put -3.75
Sell Dec. 97, 84 Call +1.75
Net* *-2.00

Min. Selling Price = (78.00 - 3.75 - 5.00) = 69.25 + 1.75 = 71.00
Max. Selling Price = (84.00 - 5.00) = 79.00 - 2.00 = 77.00

*Broker Commissions Omitted

A window of price expectations can be set up by purchasing a put option at some strike price and then selling (granting) a call option at another strike price. Margin deposits are required when selling an option. Thus, a minimum and maximum selling price are established subject to basis variation.

Purchase a December 97 put with a strike price of 78.00 cents for a 3.75 cent premium and with a 5.00 cent basis, the expected price is 69.25. Then sell a December 97 call with an 84.00 cent strike for a 1.75 cent premium. This sets the maximum price at 84.00 cents less 5.00 cent basis minus the 2.00 cent difference in premium paid and received for a maximum of 77.00 cents. The 1.75 cent premium can be added to the put side for a 71.00 cent minimum price. In effect, a price floor has been set at about 71.00 cents with a maximum price at about 77.00 cents, subject to basis variation. For this strategy, different put and call strike prices can be used to fit the desired price objective.