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  • 4.9-COTTON TRADING-TRADING PHYSICALS AT A PRICE TO BE FIXED

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  • Trading physicals at a price to be fixed

    Chapter 4 - Cotton trading - Trading physicals at a price to be fixed (PTBF) 

     
     

    Forward sales of physical cotton at a fixed price are the most straightforward form of price risk management as part of marketing. The size of the expected crop is reasonably well known, prices are satisfactory, and buyers have enough confidence in the seller to commit to them on a forward basis. This is perhaps the ideal situation, but it is seldom encountered nowadays. And when prices are very low, fixed price forward contracts look attractive only to the buyer. When the market outlook is very uncertain, many traders and spinners are reluctant to purchase physical cotton outright on a forward basis. The international trade has therefore developed a system of selling cotton without specifying a price for it, i.e. selling at a price to be fixed (PTBF) against the futures markets (or the Cotlook A Index). A relevant delivery month of the futures market is chosen, and its price at a given moment will determine (or fix) the price of the physicals contract. If the quality of the physicals is worth more or less than the quality on which the futures contract is based, the price stipulation will read (for example) ‘3 cents per pound on (or off) December’ – the plus 3 is the differential.

    The contract constitutes a firm agreement to deliver and accept a quantity of physical cotton of a known quality, under established conditions. These conditions are based on the quotation for the specified delivery month of the futures market at the time of fixing, plus or minus the agreed differential. The advantage to the buyer and seller is that each has secured a contract for physical cotton, but the price remains open. The PTBF sale sets the differential the buyer will pay in relation to the underlying futures position(s), but the general price risk and the decision when to fix remain entirely open. In other words, the PTBF sale does not mean the seller has made a price decision – that will be the case only once he or she fixes.

    In other words the seller and the buyer have now separated the operational decision to sell/buy physical cotton, from the financial decision to fix the price of that cotton, which they prefer to postpone. This arrangement provides flexibility for both buyer and seller. The obligation to deliver and accept physicals now exists but, as the price remains open, both parties can continue to play the market. The producer should realize they have only secured the market differential and that they remain exposed to price risk until an instruction is given to fix. But they have secured a home for their physical cotton, enabling them to plan ahead and to make arrangements for quality control, delivery and shipment.

    PTBF – Seller’s call contracts 

    • Generally are written to allow the price to be fixed by the seller prior to the first notice day for the specified futures contract.
    • Allow the seller to ask the buyer to fix the contract price based on the futures price ruling at the time (therefore do not require the seller to have a futures trading account).

    PTBF – Buyer’s call contracts 

    • Sometimes allow the buyer to fix the price any time before the delivery of the physicals, but usually before the first notice day of the specified futures contract.
    • Allow the buyer to ask the seller to fix the contract price based on the futures price ruling at the time (therefore, do not require the buyer to have a futures trading account).