What is a Lock Limit
A lock limit is a specified price movement determined by trading exchanges that if breached results in a lock on the trading instrument. Lock limits may be regulated and instituted differently in different types of markets.
BREAKING DOWN Lock Limit
Lock limits are used across exchanges to regulate the volatility of trading instruments. They can be common in commodities markets and stock market trading, as well as other scenarios also.
Commodity Lock Limit
Commonly associated with the futures market, a lock limit occurs when the contract price of a commodity instrument moves beyond its allowable limit. When this occurs then trading stops for the day. Limits can be limit up or limit down.
For an example, consider corn contracts trading on the market at a price of $4.50. A report from the USDA is released that is very bullish on the price for the available stock. The $4.50 price for a corn contract was the opening price for March delivery on the day of the announcement. Following the USDA report announcement the March corn futures contract goes from $4.50 to $4.90 and trading is halted. Trading is halted because the price reached its lock limit of 40 cents. This is considered a lock limit up.
Corn could also be lock limit down. Given the same scenario, but a negative announcement from the USDA that is bearish on current stock, the price falls. If the price falls from $4.50 to $4.10 the lock limit is reached and the trading is halted. Since the price fell 40 cents the halt is considered a lock limit down.
In a lock limit commodity market many advanced investors will seek to trade around the lock by using the options market. In the corn example a trader may choose to purchase options on corn to maintain their hedging strategy. Some options on commodities can be transferred to futures contracts at the end of the day which can help a trader cover the activity that was lost from the lock.
Stock Market Lock
The stock market also uses the term lock to indicate a locked market. A locked market in equities differs from options. A locked market is similar to a crossed market. A locked market occurs when bid and ask prices are the same for a particular stock across different exchanges. The Securities and Exchange Commission’s Regulation National Market System (Reg NMS) was passed in 2007 to integrate alternative trading procedures when a locked market occurs.
In other cases exchanges may implement halts or suspensions. Halts and suspensions stop the trading of stocks due to price volatility and other factors. Trading can be halted for varying periods of time.
Across the investment market other locks may also apply including the following:
Loan lock: The holding of a specified interest rate for a customer.
Mortgage rate lock float down: Holds a specified rate for a loan with an option to decrease the rate if broad market rates fall.
Treasury lock: Agreement to lock in a specified rate. Usually executed as a derivatives contract for a specified period of time.