Price limits generally refer to the maximum amount by which the price of a futures contract can increase or decrease during a trading day from the contract’s closing or settlement price on the prior day. Price limits are sometimes referred to as daily price limits or daily limits, since they traditionally dictate the amount by which a price can move in a day.
For example, the price limit in CBOT soybeans is 50 cents per bushel (except that there is no limit during the delivery month). If today’s closing price for a nondelivery month soybean contract is $10.00, then no trading tomorrow can take place at a price higher than $10.50 or lower than $9.50.
If market participants believe the value of soybeans is actually $12, then there will be only bids at 10.50 and no offers and thus no transactions. The market has essentially stopped trading. People would call this market “limit bid” or “locked limit.” this also means futures traders who wish to of set existing positions would have trouble doing so.\
Someone wanting to buy to offset a short position would simply become one of the many limit bidders unable to find a seller at that price. Someone wanting to sell to offset a long position would be able to sell at $10.50, but would be reluctant to do so knowing that $10.50 is significantly below current value.
There is an incredible variety in the structure of price limits from exchange to exchange and contract to contract. And over time, exchanges will change their rules regarding price limits on specific contracts. Some contracts such as CME currencies have no price limits.
Some price limits are very simple as in CBOT corn, which has a 20 cent per bushel limit every day except during the delivery month when there is no limit. Soybeans, as mentioned above, are structured the same, though the limit is 50 cents per bushel per day.
NYMEX energy contracts have more complex limits. Crude oil, for example, has a daily limit of $10 per barrel. However, if the contract is locked at the limit for 5 min, a 5 min trading halt is called and trading then opens with a new wider limit of $20.
Should trading still be locked limit at the $20 limit for 5 min, then another 5 min trading halt is called, after which the new limit becomes another $10 wider. This continues until the limit grows wide enough to accommodate where the market wants to go.
The most comprehensive and complicated limits are those in stock index futures, which came about in the year following the big stock market crash of October 19, 1987. These limits, which are also known as circuit breakers (because it’s like cutting the power when a market is in freefall) or trading halts (because when the price triggers are hit it calls for a temporary trading halt), have changed many times.
There are four percentage limits: 5, 10, 15, and 20%. Once a quarter, specific price limits are set by applying these percentages to the average closing price of the lead month futures contract. So if the market is limit bid or of ered at 5% for 10 min, then trading is halted for 2 min and then resumes with the 10% limit in place.
Halts and resumptions of trading are coordinated with the New York Stock Exchange for the 10% limit. Floor traded stock index contracts have halts for price declines only, while electronic markets have symmetrical limits both up and down.