Variable Price Limit
What Is a Variable Price Limit?
A variable price limit is a type of circuit breaker used to keep up with orderly trading conditions. It is associated with the commodities futures markets, which are known for their periodically high levels of volatility.
When a given futures contract has arrived at its limit price, the exchange might permit its trading to resume inside an expanded upper and lower bound of prices. Those new least and maximum prices are known as its variable price limits.
How Variable Price Limits Work
Commodities futures exchange operators like the Chicago Mercantile Exchange (CME) use price limits to control the maximum amount of volatility permitted inside a given trading day. Assuming a specific commodity rises or falls by more than the maximum permitted amount, the exchange operator can either freeze trading in that commodity or, in all likelihood permit it to keep trading inside its variable price limits.
Generally, the exchange will initially freeze trading and afterward resume trading the next day inside the variable price limits. This approach permits a 'chilling' period and furthermore permits traders to all the more effectively unwind their positions the next day. On the off chance that fruitful, these measures will initially forestall any likely panic or speculative mania from grabbing hold of the market, and afterward permit prices to progressively recuperate their fair value.
Each exchange will set its own initial price limits and variable price limits. These limits are subject to change and, as a matter of fact, a few commodities might lack variable price limits through and through. Before trading a specific commodity, traders ought to carefully survey that contract's details to ensure they comprehend how the exchange would handle periods of uplifted volatility. Contingent upon the exchange's rules, certain trading strategies that depend on rare yet extreme volatility might be troublesome or difficult to execute.
Certifiable Example of a Variable Price Limit
The Chicago Mercantile Exchange (CME) is the biggest commodities futures exchange in the world, facilitating trading in a large number of futures contracts for agricultural products, equity indexes, energy commodities, and different assets.
To show the concept of a variable price limit, consider the case of the CME's unpleasant rice contracts. As of March 2021, the price of its harsh rice contracts was subject to a fixed limit price of $0.85, implying that trading would be ended assuming the price of unpleasant rice rose or fell by that amount or greater inside any single trading day. Simultaneously, the variable price limit for harsh rice was set to $1.30. This bigger band is intended to give traders adequate move to enter or exit their positions the next day, with the goal that the market price of harsh rice could recapture its equilibrium sensibly rapidly.
Highlights
- It permits the price of a given commodity to rise or fall inside an expanded reach when after the commodity's fixed limit price was reached.
- A variable price limit is a method of controlling volatility on commodities futures exchanges.
- Various exchanges will set their own variable price limits, and a few commodities might not have variable price limits by any means.
