What Is Limit Up?
Limit up is the maximum amount by which the price of a futures contract may advance in one trading day. Limit up refers to a situation when a futures contract will have a maximum threshold to ensure that substantial unexpected or potentially catastrophic events do not push a contract's price into levels of irrational valuation based upon investor panic or manipulation.
- Limit up is used in commodity futures trading to mark the maximum level a contract can hit on a given trading day.
- Limit up contrasts with limit down, which is the maximum amount a commodity future can drop in a single trading day.
- When the price hits the threshold, either the limit up price is expanded, or trading for the day is stopped, depending on what type of contract is trading.
- The purpose of these circuit breakers is to make sure unusual events, such as unexpected geopolitical news, or a glitch in program trading, doesn't have a devastating effect on commodity futures trading.
Understanding Limit Up
A limit up price is the maximum price movement permitted for a futures contract in each trading session. The price limit is measured in ticks and varies from product to product. When markets hit the upward price limit, different actions occur depending on the traded commodity. Some markets may temporarily halt trading until the upward price limit can be expanded or trading may be stopped for the day based on regulatory rules. Different futures contracts will have different price limit rules.
Limit up is a type of circuit breaker on a futures contract's price movements. If there is a significant event affecting the market's sentiment toward a particular commodity, it may take several trading days before the contract price fully reflects this change. When this happens, the trading limit up price will be reached for the day before the market's equilibrium contract price is achieved.
The Chicago Mercantile Exchange (CME) says it is important to note, however, that traders can place trades above the daily limit up price, but these trades will only execute when the limit up price is reached. Traders can still set good-til-canceled or good-til-date orders inside and outside daily price limits.
Price Limit Updates
Commodity exchanges like the CME publish daily price limits on their website. They also have stringent rules about how far a commodity future contract can move in a trading day. For example, corn futures have two limits up levels (Level 1 & 2). Level 1's limit up is 25 dollars and Level 2's ceiling up is an additional 15 dollars, making the total limit up for the trading day 40 dollars. These limits are recalculated daily. The only time when these price limits are lifted is in the month when the futures contract expires to allow room for futures prices to converge with the underlying commodity spot price.
Limit up pricing rules have helped reduce market volatility over the years. The CME says that the number of days in a trading year when commodity futures have traded limit up have been fewer and fewer.