Unscramble The "Crisis Mode" Of Cotton Futures Operation

Keywords: ICE futures, volatility, financial crisis, options, detrend

"Value is not the number itself, but the difference between numbers."

Nobel, the winner of "thinking, fast and slow", and Daniel Kahneman Laureate in Economics

The rain is coming.

Looking back on history, since 2015, the Federal Reserve has begun to raise interest rates, shrink its balance sheet, and the global trade protectionist forces are on the rise. The frequency of international economic and geopolitical crises has increased considerably since the financial crisis.

Overall, after 2015, the global market has experienced the exchange rate reform of the people's Bank of China, the election of the new US president, the UK's departure from Europe, the sharp adjustment of the US stock market, the geopolitical crisis in Turkey, and the Sino US trade friction which has led many global risk events since last year.

Most of these short-term or long-term crises have triggered a sharp decline in global stock markets and commodities.

In the field of cotton, if we observe the whole historical trend of the ICE cotton futures since 1959, we can only see that the long term business cycle fluctuates with the short-term substandard trend, which is inundated in the long history. Each wave rises or falls, which seems to be different in magnitude, duration and angle of movement. It is difficult to find a similar rule (Fig. 1).

Figure 1 historical trend chart of the main contract settlement price of the 2 cotton futures exchange of the ICE stock exchange of the United States

But if we adopt a certain method to remove the trend of the original price series, we can remove the trend factors such as the rising cost of planting caused by economic growth and the upward movement of price center caused by inflation, so we can compare the similarities and differences between each rise and fall in a clear and equal way.

Similar to the use of the year-on-year approach to eliminate quarterly changes in economic data, the main purpose of trend processing is to eliminate the medium and long term factors contained in the price series.

In this paper, we simply use the "day price - the past 100 days median" method to carry out rolling calculation (parameters are not special). After detrending processing, the original price sequence is pformed into a Stationary Time Series. All the large and small ups and downs in history are compared on the same running line.

Contrary to our intuitive perception of the original price, in 2010, the huge price of the international cotton price fluctuated in the history of ICE cotton trade in the past 60 years, and it only ranked second in history after the oil crisis in 1973 (Figure 2).

Figure 2 ICE cotton futures main contract stable time series (1959 to date)

With the completion of the task of stocking cotton stocks, domestic cotton prices should start to logically lead back to supply and demand fundamentals. However, since the end of April this year, Sino US trade consultation has become tense again, and external pressure has suddenly started to rise. ICE cotton futures have started to fall, and in early May, they were quickly suspended.

Looking back at the trend of domestic and foreign cotton futures from the end of 4 to the beginning of May, we can clearly see a "crisis logic" triggered by trade friction.

We can enlarge the graphics of ICE cotton after 2011 so far. We can see that this sharp downward cycle seems to be a relatively ordinary downward trend even in the 8 years since the 2011 cotton price has been relatively stable for 4-5 months.

Therefore, in the face of the short term and rapid trend of market fluctuation, on the one hand, it does not need to make a big fuss about it, should face the market risk with a normal mind; on the other hand, it is precisely because the decline in cotton futures can not be regarded as a "huge margin". We should also be very cautious about the long term, deepening and comprehensiveness of the Sino US trade frictions, resulting in a significant expansion of the cotton price decline. We should fully guard against the possibility of the coming global commodity revaluation and industrial relocation from psychological perspective (Fig. 3).

Figure 3 ICE cotton futures main contract stable time series (2011 to date)

"No wind, no sail, and benevolence".

At all times and in all over the world, people have long described the characteristics of human nature. As early as hundreds of years ago, "Holland tulips foam" and "South China Sea bubble", to the twentieth Century "Great Depression", "oil crisis", "Internet bubble", and financial market fluctuations such as "subprime mortgage crisis" and "European debt crisis" since the beginning of the new century, people in front of the general trend of the market are all thrilling and awed by this devastating power.

However, after the turmoil subsided, the market reappeared and the price trend returned to calm. The "sky" of the market never collapsed.

The facts of repeated financial crises have proved that most of the short-term violent fluctuations are caused by the floating of people in the market. People's subjective emotions and behaviors have an important impact on the short-term trend of prices. On the face of it, the relationship between the behavior of the traders and the market trend seems to be contrary to the objective view that we always believe in "material decision consciousness". However, in recent 20 years, the economic circles pay more and more attention to the study of behavioral finance. Since 2002, scholars in the behavioral finance field have been awarded the Nobel prize in economics many times.

As the Time Series, the short term trend of commodities is full of various market noises. Therefore, it is very difficult to predict the trend of a commodity price. However, it is possible for us to predict the trend of its fluctuation.

Despite the rapid development of modern information technology, new technologies such as big data and artificial intelligence have gradually penetrated into the field of financial pactions. But in the futures market and even the spot trading area, the main body of decision-making on its final trading is always a flesh and blood mortal. As long as people are faced with commodity prices fluctuating every day, there will be panic and greed. Cotton / cotton yarns are also an important area of international commodities, and no exception.

To clarify the impact of traders' behaviors and emotions on the market trend, we must introduce the concept of volatility.

The so-called volatility refers to the measurement of the degree of volatility of financial assets in the coming period. Since the future yield is a stochastic process, the actual future volatility is always unknown and can not be accurately calculated. Therefore, we can only estimate the future actual volatility through various other ways.

Historical volatility refers to the volatility of assets in the past period of time. It is calculated by means of statistical methods, and is also known as realized volatility.

Historical volatility not only reflects the fluctuation of financial assets in the statistical period, but also is the basis for analyzing and forecasting other types of volatility.

Implied volatility is a concept derived from the option price. It selects a set of virtual options of the specific asset maturity date. It is calculated through the Black-Scholes option pricing model. It reflects the expectation of the stock market to the volatility of the future period. During the sharp fluctuation of assets, the panic buying is triggered by the strong demand of the buyer of the option, and then the implied volatility is greatly raised. Therefore, it can reflect the panic of the traders in the derivatives market from the side.

As early as 1993, the Chicago Commodity Options Exchange (CBOE) launched the VIX index, which was originally designed to measure the market expectations of the 30 day volatility of the S & P 100 index. In 2003, the Chicago options exchange, together with Goldman Sachs, based on the theory of variance swap, improved the compilation method of VIX index and enhanced its market representativeness.

The following figures show the characteristics and calculation paths of several kinds of volatility (Fig. 4).

Fig. 4 estimation method of real volatility of commodity futures

Specific to the commodity market, at present, the volatility index issued by major global exchanges is also less. Typical oil price volatility index (OVX) and gold price volatility index (GVZ) and so on. We can clearly see that the price of commodity futures has a significant negative correlation with its volatility level through the comparison of the main trend of convergence of WTI light crude oil futures and the OVX index since 2006. During the "small financial crisis" after the subprime crisis, with the collapse of commodity prices, the implied volatility index did not rise sharply in the short term.

In addition, after these crises were recovered, commodity prices gradually recovered, and the volatility index also dropped to the long-term average water level, which confirmed that volatility did have a "mean reverting" characteristic (Fig. 5).

Fig. 5 Comparison of WTI crude oil futures and crude oil volatility index (OVX) trend

Taking the OVX index as the observation window, we can conclude that since the US launched the "301 survey" in 2018, the three volatility of the international commodity market has been closely related to trade frictions.

This proves that with the help of derivatives market, volatility can not only reflect part of the future information, but also reflect the pmission path of asset price changes.

In addition, in the past crisis events, the linkage between large categories of assets has increased. It shows that global geopolitical and economic trade frictions will spread rapidly in all kinds of markets. In the face of the historical changes in the Sino US trade pattern, which has not changed in the past decades, the commodity market, especially the cotton market, is likely to get rid of the more stable state in the past few years, and the market volatility is frequent. This will also lead to the gradual upward shift of the long-term mean value of the volatility.

Just like the numerous crises of great and small scale in history, with the ups and downs of the trade situation, the short term panic fall will always end. Cotton prices will eventually return to reason. But such a sharp trend will make the market fully competitive. We should take a more macro view of cotton flowering and spot movements, and correctly use all kinds of derivatives tools to manage investment risks.

Finally, it is gratifying to note that domestic regulators have begun to pay attention to the role of financial derivatives in price discovery and risk management. Zheng has launched white sugar, soybean meal and cotton options. Although these derivatives are immature, low activity and narrow participation groups, in the future, as China's financial market is further mature and open, the cotton industry will also be able to raise its risk management level by means of various derivatives. This is no longer a distant vision of the future, and is now in progress. Let's wait and see.