ICE Actively Considering Addition of New Cotton Contract
November 27, 2012 
Among the hottest topics of discussion in the cotton universe are transparency in price discovery, the possibility of creating a non-U.S.-origin cotton contract, and what can be done to help mills better manage their business risks.
The Intercontinental Exchange (ICE) in New York is the global center of cotton trading, so Cotton International engaged Ben Jackson, the president and COO of ICE Futures U.S., to offer his views on those topics and shed some light on the future direction of cotton trading.
1 Is there currently a need for a better price discovery process in the global cotton industry? Why or why not, and what are the industry’s options?
For more than half a century, the delivery terms of the Cotton No. 2 futures contract have required U.S.-origin cotton at U.S. delivery points, with no other origins or delivery points permitted. Despite this U.S. focus, the No. 2 contract has functioned as the global benchmark for the cotton trade.
While the U.S. remains the world’s leading cotton exporter, some market commentators have expressed concerns about the potential for a divergence between the Cotton No. 2 price and world cotton prices that could result from the contract’s U.S.-focused terms.
In response to these concerns, ICE Futures U.S. has begun consulting with a diverse range of market participants about the desirability and feasibility of listing a new contract that would allow delivery of non-U.S. origin cotton and also allow delivery outside the United States. If such a contract could be developed, it would most likely trade alongside Cotton No. 2 and offer market participants an additional price discovery and risk management tool. It’s important to note that there is no consensus among market participants on this issue and no decisions have been made by the exchange at this point. But consultations continue and the exchange is interested in hearing from Cotton No. 2 market participants.
2 How can mills take better advantage of their hedging options to lessen their risk, and have you seen – or do you expect to see – greater mill participation in this area in the coming years?
In the [April] issue of Cotton USA, I discussed the potential utility of options on futures as a risk management tool. For physical hedgers and other cash market participants, options are a way to limit risk without also limiting the ability to benefit if the market moves in a desired direction.
Options provide execution flexibility because they can be liquidated or exercised at the owner’s discretion. The purchase of options also offers economic efficiency, because the risk to the buyer is limited to the premium paid for the purchase of the put or call and because margin is not assessed on long options. (Margins are charged on short positions, however, and will be charged if long positions are exercised into futures.)
Because of the potential complexity of options strategies, options trading initially lagged futures in transitioning from floor to electronic execution. However, with the addition of user defined spreads (UDS), requests for quotes (RFQs), creation of live calls, puts, strategies and other options-trading capabilities to the WebICE trading platform, options trading volume is shifting rapidly toward electronic execution. In June 2012, more than 50% of cotton options volume was transacted outside of open outcry, compared to 28% in December 2011 and less than 10% in June 2011. As options market accessibility continues to increase, I am confident that participation by commercial users, including mills and others who may not have participated previously, will also increase.
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