Position Limit

What Is a Position Limit?

A position limit is a preset level of ownership laid out by exchanges or regulators that limits the number of shares or derivative contracts that a trader, or any affiliated group of traders and investors, may claim.

Position limits are put in place to keep anybody from utilizing their ownership control, straightforwardly or through derivatives, to exercise unilateral control over a market and its prices.

Understanding Position Limits

Position limits are ownership limitations that most individual traders are never going to have to worry about breaking, yet they truly do form an important purpose in the derivatives world.

Most position limits are basically set too high for an individual trader to reach. Nonetheless, individual traders ought to be thankful these limits are in place since they give a level of stability in the financial markets by forestalling large traders, or groups of traders and investors, from controlling market prices and utilizing derivatives to corner the market.

For example, by buying call options or futures contracts, large investors, or funds, can build controlling positions in certain stocks or commodities without purchasing real assets themselves. Assuming these positions are adequately large, the exercise of them can change the balance of power in corporate voting blocks or commodities markets, making increased volatility in those markets.

For instance, in 2010 a hedge fund called Armajaro Holdings purchased almost a quarter-million tons of cocoa and caused a price move that was statistically strange. Cocoa arrived at all-time highs from the get-go in the year and futures contracts were in their highest state of backwardation at any point recorded.

Cocoa crested in value ahead of schedule in 2011, yet started declining from that point. After six years, the fund lost money on its cocoa investments as the price of cocoa fell 34% in 2016 en route to making its least prices in a decade. The episode showed two points of perception: cornering endeavors can make statistically unusual price swings, and the work is famously troublesome and rarely worth the work.

How Position Limits Are Determined

Position not set in stone on a net equivalent basis by contract. This means that a trader who claims one options contract that controls 100 futures contracts is seen equivalent to a 100 individual trader futures contracts. Everything revolves around measuring the control a trader can apply over a market.

Position limits are applied on a intraday basis. While a few financial rules apply to the number of holdings or exposure a trader has toward the finish of the trading day, position limits are applicable all through the trading day. If whenever during the trading day a trader outperforms the position limit, they will be in violation of.

Traders might receive an exemption from a forced position limit from the Commodities Futures Trading Commission (CFTC) in certain occasions.

Special Considerations

One more form of limiting influence on market prices is the change in margin requirements. Expanding margin requirements may not block an individual investor or group of investors, however it will increase the capital reserves important to hold similar number of positions, making it significantly more costly to corner the market.

For instance, in 2011 the margin requirements for gold and silver were changed, leading the prices of both precious metals to fall after strong rallies.

Highlights

• Position limits are laid out to block any entity from applying undue control over a specific market.
• These limits are generally made with respect to total control of the number of shares of stock, options, and futures contracts.
• Position limit sizes shift from one market to another.
• The primary goal is to stay away from the manipulation of prices for personal benefit to the detriment of others.