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Limit Up Limit Down Question
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Limit Up Limit Down Question

  #1 (permalink)
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Limit Up Limit Down Question

I am new to trading futures. Day trading is my interest. I am currently educating myself and will begin sim trading shortly. I am leaning toward trading the ES and 6E, but am also looking into NQ, CL, ZN and ZB. My approach will be price action, with an emphasis on trendlines and support/resistance areas.

I have recently come across the concept of Limit Up and Limit Down. My understanding is that these are the maximum amounts by which the price of a futures contract may advance or decline in one trading day. So it's the highest and lowest amount a contract can be traded before an exchange halts trading.

My questions on this are as follows :

1. Are all futures contracts potentially affected by this, particularly those mentioned above?

2. Is this a relatively frequent occurrence, or is it rare?

3. What are the implications for a day trader?

4. Are there any of the instruments mentioned above that I should stay away from as a day trader for this reason or others?

Thanks very much for your time.

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  #3 (permalink)
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1. Whether or not a futures contract is affected by price limits depends on the rules and specifications that govern that contract. Before you trade a futures contract, you should enquire whether limits apply.

Your question was mainly about CME traded contracts. As to my knowledge, price limits apply to agricultural futures and index futures. Here are some links that provide for information:


For agricultural futures you can find the current price limits here:

Price Limit Update

For index futures there are temporary trading halts (circuit breakers) and limits applying to the entire trading day.

Stock Index Futures Price Limits Effective for the 1st Quarter 2013:

Limit Up Limit Down Question-pricelimitguide.pdf

New rules applicable after April 7, 2013:

Limit Up Limit Down Question-ser_6547_delay_in_implementing_equity_index_futures_price_limt_rules_until_08april2013.pdf

2. It is a rare occurence. Let us for example have a look at the year 2012 for ES and ZC.

ES : limits applicable were 5% for the night session and 10%, 20% & 30% for the trading day. There was not a single day in 2012, for which one of the limits was reached. ES made a sudden 50 point down move during the night session on December 21, which came close to the overnight limit. On August 9, 2011 the S&P 500 was down about 4% in the morning, still far from the 10% decline required for the first circuit breaker. The last significant event was the flash crash on May 6, 2010 which led to the introduction of circuit breakers.

ZC: Limit moves are more frequent for agricultural commodities.

January 12, 2012: Corn was locked limit down for one day after USDA revised the corn production for 2011 to the upside. The price decline continued next day, before price reversed.
March 30, 2012: Corn was locked limit up after the release of the USDA stock report. The price advance continued next day, before price reversed.
June 25, 2012: Corn was locked limit up due to weather concerns. The price advance continued over the next weeks.
July 9, 2012: Corn was temporarily limit up amongst fears for a nationwide drought.
July 24, 2012: Corn was temporarily limit down, after it had moved to a new high the day before.
September 28, 2012: Corn was locked limit up, after a USDA report announced an unexpected decline in end-of-season stocks. The price advance did not continue next day.

That made 6 events per year, three of them triggered by USDA reports, two of them triggered by fears for a drought.

3. The limit moves were introduced to protect traders from large moves that are triggered by emotions and other positive feedback loops. They do not add to market risk. These are the implications for traders:

-> know when the USDA reports are released
-> take into account that a position can move against you more than a limit move (40 cents for corn), before you will be able to get out
-> take into account that lock limit moves may inflict psychological pain on you, as you will be unable to exit your position and clear your head

4. Make a worst case scenario based on the most adverse occurences over the last 10 years and prepare accordingly. In particular, adjust position sizing in a way that you will survive a limit move.


Last edited by Fat Tails; February 18th, 2013 at 06:07 PM.
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  #4 (permalink)
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Another Price Limit Question

Thanks for that answer. One more question comes to my mind :

For those futures contracts affected by price limits, what initial price is the limit based on? The open of the US markets (i.e. 9h30 am EST)?

During the trading day, if one knows that the price limit is fast approaching for a given instrument, then the prudent decision would be to not enter that market until equilibrium appears to have returned. Am I reading this correctly?

I guess that was two questions...

Thanks very much.

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based on closing price or prior session

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"Corn futures have a price limit of 30 cents for the day. Suppose December corn closed at $3.30 the previous day. December corn futures can only trade as high as $3.60 or as low as $3.00 during today's trading session. No orders can be filled ouside of those limits."
Limit Move - Meaning of Limit Up or Limit Down in Futures Contracts


--partial protection with options-------

One idea I have considered for locked limit situations is an option in the other direction. So if I was short corn at 720 I might have a call option for the same month at 760 (or 750), to get partial protection. To get more protection you would have to be at or in the money.

I couldn't find if the options stop trading when the underlying is locked but I believe they continue to trade.

some links:
basic on options
http://agmarketing.extension.psu.edu/Commodity/PDFs/Future_options_eginners.pdf

short dated options
Short-Dated New Crop Options - CME Group

rulebook for options on Corn Futures
http://www.cmegroup.com/rulebook/CBOT/II/10A/10A.pdf

delayed quotes
Delayed Agriculture Commodities Futures Quotes - CME Group

Keep your mind in the future, in the now.
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  #6 (permalink)
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MV007 View Post
1. Are all futures contracts potentially affected by this, particularly those mentioned above?

Yes.


Quoting 

2. Is this a relatively frequent occurrence, or is it rare?

Rare, but if you survive trading for long enough, you will encounter it. Meaning you should always be prepared for it. You don't need to be concerned just "limit moves", you need to be concerned with limit-move- type of events, meaning those events where the price moves a huge amount in one direction, sometimes instantaneously, due to external events.


Quoting 
3. What are the implications for a day trader?

Can wipe you out in a matter of minutes unless you use puts and calls to limit your losses.


Quoting 
4. Are there any of the instruments mentioned above that I should stay away from as a day trader for this reason or others?

Limit moves or "limit-move"-type events can happen anytime. You need to factor this into your trading strategy.

If you have a hard time understanding how something so rare can be a threat, I suggest reading a nifty little book called "When Supertraders Meet Kryptonite" by Art Collins. Despite the funny title, it's a nice story of all the wonderful ways that a good trader can get wiped out.

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aquarian1 View Post
One idea I have considered for locked limit situations is an option in the other direction. So if I was short corn at 720 I might have a call option for the same month at 760 (or 750), to get partial protection. To get more protection you would have to be at or in the money.

I couldn't find if the options stop trading when the underlying is locked but I believe they continue to trade.

Yes they continue to trade. Some people use options after the limit move has occurred, to try and limit further damage. I personally do it as a preventative measure - every time I start trading the new contract month, I buy puts and calls in order to have some protection against these type of occurrences.

It's prudent. History is full of traders who did everything right for months on end, only to have one wild day wipe it out.

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MV007 View Post
Thanks for that answer. One more question comes to my mind :

For those futures contracts affected by price limits, what initial price is the limit based on? The open of the US markets (i.e. 9h30 am EST)?

During the trading day, if one knows that the price limit is fast approaching for a given instrument, then the prudent decision would be to not enter that market until equilibrium appears to have returned. Am I reading this correctly?

I guess that was two questions...

Thanks very much.

@MV007: The limit price is based on the settlement price of the prior trading session. For example if you want to know tomorrow's limit price for March 2013 corn futures, you would take Friday's settlement price (because today the agricultural markets were closed) and add 40 cents for the limit up and then deduct 40 cents for the limit down move. For tomorrow you will obtain the values

limit up = 698'06 + 40 = 738'06 cts
limit down = 698'06 - 40 = 658'06 cts

Your second questions depends on how the limit is approached. When volatility is high I would probably not try to enter a position, as you may experience a high slippage. However, you may always exit a position, if the market moves in your favor.

Below are the two last trading days when ZC was locked limit up. The absolute price are not correct, because I use a mergebackadjusted chart, but the relative price moves show what happened.

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One thing to note, when it comes to trading options in a locked-limit environment, is that you can create synthetic futures contract using options to hedge your risk ... and believe me, when a market is locked-limit, everyone scurries to the options markets to find out where the synthetics are trading at. It's not perfect, of course, because if everyone is pouring into the options markets to hedge their risk, the cost of that insurance is going to go up ... but it can be worth it if you expect the market to move against you further.

A long synthetic futures contract is made up by being long 1 call and short 1 put with the at-the-money strike price for the same expiration month as the futures contract you're trying to replicate. A short synthetic futures contract is made up by being long 1 put and short 1 call with the at-the-money strike price for the same expiration month as the futures contract you're trying to replicate.

In order for a synthetic futures contract to provide a perfect hedge for an actual futures position, you will need to have a strike that is equal to the prevailing price of the futures contract and with the exact same expiration date as the futures contract. Obviously, in a locked limit environment knowing the true value of a futures contract may be hard but brokers in the options pits can tell you at which strikes the synthetics are being traded.

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furytrader View Post
One thing to note, when it comes to trading options in a locked-limit environment, is that you can create synthetic futures contract using options to hedge your risk ... and believe me, when a market is locked-limit, everyone scurries to the options markets to find out where the synthetics are trading at. It's not perfect, of course, because if everyone is pouring into the options markets to hedge their risk, the cost of that insurance is going to go up ... but it can be worth it if you expect the market to move against you further.

Or buy OTM options at the beginning of the month before you begin your trading and hold them through expiration and look at it as simply the cost of doing business.

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