Weak demand drags down cotton prices, cotton yarn prices continue to fall, and the market is cautious about the trend of cotton prices...
According to recent reports from China Textile Daily, in the face of cotton price fluctuations, more and more cotton-related enterprises are choosing to use financial tools such as futures and options to manage risks and guide their production and operation. Taking the initiative has become a concept for many cotton textile enterprises to achieve stable operation.
Effective Risk Management
Fluctuations in cotton prices have increased the uncertainties facing the cotton textile industry chain. For cotton processing enterprises, the time difference between purchasing and selling brings uncertainty to cotton prices, which is the main risk they need to face; for cotton spinning enterprises, it is difficult for enterprises to grasp market price fluctuations, and they always face the risk of rising raw material costs. Effective risk management is a required course for cotton-related enterprises. Among them, "financial tools" play an important role.
“The emergence of financial derivatives has enabled enterprises in the cotton industry chain to no longer be passive. The key for enterprises is how to use them,” said a relevant person in charge of a large domestic cotton trading company. Cotton spinning enterprises purchase raw cotton to produce cotton yarn, and fluctuations in the prices of both raw cotton and cotton yarn will bring risks. Risk management needs to start from five aspects: first, to clarify its own business model and the main risks faced; second, to confirm its own risk preference; third, based on market research and development to evaluate the market state; fourth, to be familiar with the rules of financial derivatives; and fifth, to comprehensively make targeted risk management strategies.
Risk control and seizing opportunities are the core principles for cotton-related enterprises to use financial tools. Peng Lihu, head of the Futures Department of Xinjiang Guanong Co., Ltd., said that cotton-related enterprises should actively embrace financial tools, use derivatives such as futures and options to flexibly manage risks, thereby avoiding price fluctuations and market uncertainty risks, and enabling enterprises to achieve better returns in their operations.
Henan Tongzhou Cotton Industry Co., Ltd. (hereinafter referred to as "Tongzhou Cotton") is an international enterprise integrating cotton acquisition and processing, cotton textile and garment production, and import and export trade. When talking about how to deal with cotton price fluctuations, Huang Hongyu, president of the company, said: “In recent years, cotton prices have fluctuated greatly, which has had a great impact on cotton-related enterprises such as ginning mills, traders, and spinning mills. The reason why we can move forward steadily in the turbulent market is that we regard risk management as the lifeline of the enterprise and take the initiative by using financial tools.”
Flexible Use of Tools
For cotton-related enterprises, it is not enough to just have the awareness of participating in risk management and the courage to embrace financial tools. In actual operation, understanding the advantages of different tools and flexibly applying them according to the enterprise's own situation is the key.
“Hedging is the most basic method. Compared with futures, using options for hedging has unique advantages, more flexible operations, and can better meet the customized risk management needs of enterprises. Enterprises can achieve insurance effects by buying options and income compensation by selling options,” said the person in charge of the above-mentioned large cotton trading enterprise.
Peng Lihu believes that for enterprises, hedging mainly plays a role in reducing costs. Enterprises have corresponding needs in terms of controlling procurement costs, ensuring sales profits, and reducing risks in various aspects from production and operation to trade. “In the process of participating in hedging, enterprises develop risk management plans based on a comprehensive analysis of futures derivatives. By using futures and options derivatives, combined with the actual operating conditions of the enterprise, a risk management strategy that is more suitable for the enterprise's needs can be developed to reduce various risks in the production process of cotton enterprises.” Peng Lihu said that in different scenarios, the combined use of derivative tools has different strategies. Based on market changes and the actual situation of the enterprise, especially the capital situation, flexibly adjusting the use of futures and options tools can effectively manage different risks for the enterprise.
“Futures and options can also be combined with spot transactions, and the most commonly used is basis trading, which changes the original one-price spot purchase and sales model, and in essence, it is a hedging strategy that transfers some market price fluctuation risks. Because basis fluctuations are relatively small, pricing based on the basis can avoid a large part of market fluctuation risks.” Chen Minghong, deputy general manager of China Textile Group and general manager of China Textile Group's cotton business department, said that locking basis + futures is the most widely used method in the industry now. When the spot price is not suitable, the buyer locks the basis, locks the cotton resources, meets the cotton needs, and looks for opportunities to price at a suitable price to achieve the final procurement settlement; or the enterprise buys hedging when the futures price is suitable before deciding on the cotton demand, and after the demand is clear, according to the raw cotton batch and basis, the final procurement price is determined.
Safeguarding Enterprise Development
After years of development, Chinese cotton-related enterprises have become more and more mature in their use of futures tools, and according to their own development situations, cotton-related enterprises have developed their own risk response experience and strategies.
Since the beginning of this year, cotton market prices have been falling. During this period, Xinjiang Guanong Co., Ltd. actively adopted protective strategies, and after analyzing its inventory, it locked in the risk of falling cotton prices through hedging, achieving very good results.
“At the end of 2023, the cotton market situation was not very good, and the cost was high during the ginning mill production process. Based on the corresponding risk analysis, purchasing in the futures market may be better than purchasing in the spot market. Therefore, Xinjiang Guanong Co., Ltd. did some hedging procurement. Subsequently, cotton prices rose, and the company benefited from hedging, which effectively controlled procurement costs,” Peng Lihu said.
Tongzhou Cotton has always regarded risk control as the basis for the company's development and has taken steady operation and steady progress as its development keynote. The company makes full use of futures and options tools to avoid risks, and at the same time explores the use of new combined spot and futures operating models such as basis trading and option trading.
“Currently, the characteristics of domestic cotton trade links are: first, basis trading is the main method; second, the participating team is constantly becoming younger. In terms of specific operations, everyone feels that it is more difficult this year, so enterprises need to use futures fluctuations to continuously optimize the basis, and also use tools such as option trading to reduce costs,” Huang Hongyu said. To solve the problem of "cotton cannot be bought at a low price and cotton yarn cannot be sold at a high price", firstly, cooperate with ginning mills, give full play to the advantages of traders' funds and risk control experience, and obtain income through providing value-added services. Secondly, seize opportunities, use futures fluctuations, and purchase at a time when futures prices are high and the basis is relatively low to obtain income. Thirdly, lock the basis and use over-the-counter options for pricing, especially using accumulated purchase options for pricing when the futures volatility is large.
Zhu Chuanyu, deputy general manager of Shandong DaYin Textile Group Co., Ltd., said that at present, the industry has entered a stage of high-quality development, which requires enterprises to improve their abilities in many aspects, make full use of relevant tools through refined use, give full play to their own advantages in the industry chain, form a stable operating model and expand their operations.
