Terms

Lock Limit What It Is How It Works Example

Lock Limit What It Is How It Works Example

Lock Limit: What It Is, How It Works, Example

What Is a Lock Limit?

A lock limit is a price movement determined by an exchange that, if breached, results in a trading halt beyond the lock limit price. Lock limits are primarily used in futures markets, with the terms "curbs" or "circuit breakers" used in stock markets.

Lock limits regulate markets and keep them calm and orderly. Traders can still transact at the lock limit price, or inside of it, but trading is halted outside of the lock limit price. Lock limits may be temporary, such as five minutes, or in place for the day. Each futures contract has lock limit specifications.

Lock limits are relatively uncommon and may be regulated differently among exchanges.

Key Takeaways

  • A lock limit is a price move that temporarily halts trading in a futures contract.
  • This halt gives traders time to digest news and attract new liquidity.
  • Lock limits can last five minutes or the entire day, depending on the specific contract.
  • Lock limits can be variable, meaning the limit changes the next day if a market settles at the limit price.

Understanding a Lock Limit

Lock limits are used across exchanges to regulate volatility in trading instruments. They are used in both futures and stock markets, with the term circuit breaker being more common in the stock market.

READ MORE  What Are Crypto Tokens and How Do They Work

Lock limits are in place at all times and applied to both upside and downside moves. For example, if the limit on corn is $0.25, a $0.25 move up or down triggers a lock. If the price drops, trading doesn’t take place below the lock limit (limit down). If the price reaches the upper limit, the futures contract is limit up. Trading can’t occur above this level during the lock.

Depending on the futures contract, trading may be halted entirely during a lock limit or only inside the lock limit price. For example, if the price is limit down, a big buyer could step in and buy from the sellers at the lock limit price, then bid the price up to push it away from the lock limit. Trading would then occur as usual as long as the price stays above the lock limit. In other cases, the futures contract may be suspended for the day once the limit is reached.

The next day, a new lock limit price is instituted and trading can resume within the new limit.

How Lock Limits Work

In the futures market, a lock limit occurs when the contract price of a commodity instrument moves beyond its allowable limit. When this occurs, trading stops for the day at that price. Limits can be either limit up or limit down.

For example, if soybean meal trading closed at 300, with a lock limit of 20, a move to 320 or 280 triggers the lock limit. If the market goes limit up, trading can’t take place above 320. If the market goes limit down, trading can’t take place below 280.

READ MORE  Lodging Expenses What They are How They Work

Some futures also have expanded or variable limits. If multiple contracts for different months go limit up or limit down, the limit is expanded the next day. For example, if soybean meal has an expanded limit of 29 and is limit down at 280, the next day’s limit down is 250 and the limit up is 310. The expanded limit remains in effect if the price goes limit up or limit down again, but contracts back to 20 if the expanded lock limit isn’t hit.

Some traders use options or exchange traded funds (ETFs) to trade around a lock limit situation.

Real World Example of a Lock Limit

Assume a lumber trader wants to know the limits based on the current price as a major news announcement is due out today. The current limit is 19. Assume lumber is trading at 319. The upside limit price is 338 and the downside limit price is 300.

Lumber also has an expanded limit of 29. At the time of the transaction, the expanded limit is 29. If lumber settles at the limit up or limit down price today, the expanded limit will come into effect tomorrow.

If the price immediately drops to 300, the market is now limit down and trading doesn’t take place below this price. The trader can try to sell at 300, but finding buyers is unlikely. If there are buyers, the price may be starting to move up and away from the limit down price.

If contracts for different months settle limit down, the next day’s new limit is 29. This means the new limit down is 271 (300 – 29). If the price opens at 290, the trader can get out of their position with a loss.

READ MORE  What are Financial Securities Examples Types Regulation and Importance

If the market continues to drop and settles at 271, the expanded limit remains in effect the next day and the limit down becomes 242 (271 – 29). If the price settles above 271 (and below 329), the expanded limit hasn’t been triggered and the 19 limit is reinstated above and below the closing price.

Other Financial Uses of the Term "Lock"

Other types of locks in the financial world include:

  • A loan lock is when a specified interest rate is held by a lender for a specific period.
  • A mortgage rate lock float down holds a specified interest rate for a loan with an option to decrease the rate if market rates fall.
  • A Treasury lock is an agreement to lock in a specified rate, usually executed as a derivatives contract.
  • A lock-up agreement is a provision preventing insiders of a company from selling their shares for a specified period, commonly used in IPOs. Lock-up periods typically last 180 days but can be as brief as 90 days or as long as one year.
  • Locking in profits refers to the realization of previously unrealized gains accrued in a security by closing all or a portion of the holdings.

Leave a Reply

Your email address will not be published. Required fields are marked *