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Variable Price Limit What It is How It Works

Variable Price Limit What It is How It Works

Variable Price Limit: What It is, How It Works

What Is a Variable Price Limit?

A variable price limit is a circuit breaker used to maintain orderly trading conditions in commodities futures markets known for their volatility.

Once a futures contract reaches its limit price, the exchange may resume trading within an expanded upper and lower bound of prices, known as variable price limits.

Key Takeaways

  • A variable price limit controls volatility in commodities futures exchanges.
  • It allows the price of a commodity to rise or fall within an expanded range after the fixed limit price is reached.
  • Exchanges set their own variable price limits, and some commodities may not have any.

How Variable Price Limits Work

Commodities futures exchange operators, like the Chicago Mercantile Exchange (CME), use price limits to control volatility. If a commodity exceeds the permitted amount, trading may be frozen or allowed within variable price limits.

Often, trading is first frozen and then resumed the following day within the variable price limits. This approach provides a ‘cooling-off’ period and allows traders to unwind their positions more easily. These measures prevent panic or speculative mania and facilitate a gradual recovery of prices.

Each exchange sets its own initial and variable price limits, which may change. Traders should review a contract’s specifications to understand how the exchange handles volatility. Certain trading strategies reliant on extreme volatility may be difficult or impossible to execute based on the exchange’s guidelines.

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Real-World Example of a Variable Price Limit

The Chicago Mercantile Exchange (CME) is the largest commodities futures exchange, facilitating trading for various assets, including rough rice contracts.

For instance, the CME’s rough rice contracts had a fixed limit price of $0.85 in March 2021. Trading would halt if the price rose or fell by that amount or more in a single day. The variable price limit for rough rice was set at $1.30, providing traders with a wider band to enter or exit positions the following day and allowing the market price to stabilize more quickly.

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