What is the relationship between cotton futures and soybeans futures? The relationship between soybeans and cotton is interesting because both crops grow in the same conditions. When the price of soybeans goes up, farmers are more incentivized to plant soybeans because they will make more money on the crop than cotton. When the price of soybeans decreases, farmers are incentivized to grow cotton because they will receive more money for the crop.
This was covered in the last episode in more detail (along with some insight into the the cotton industry and some basic information about the cotton futures contract).
International cotton markets also impact the price of cotton exported by the the U.S.. If China or India (the two largest producers of cotton) have a smaller yield than normal, prices for cotton from the U.S. will typically rise to make up for the shortfall (the U.S. is the largest exporter of cotton in the world).
If we are looking to trade cotton, but want to place a spread trade to hedge our risk, we first want to look at it’s correlation with other products. Because of it’s ties to other grains, we want to look and see if there are correlations between cotton and soybeans (/ZS) or corn (/ZC). Then, because cotton futures are priced in US dollars, we also want to see how it correlates to the US dollar index (/DX).
The results of the correlations are below:
1 Month Cotton Correlations
3 Month Cotton Correlations
We also looked at the 24 month correlation (seen in the video) and the strongest over time was corn and cotton. TO place a spread trade on the correlated products, we would sell a cotton future and buy a corn future.
Strategies: Futures Spread
Products Discussed In This Episode: /CT, /ZC
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