Definition
The term daily trading limit refers to the maximum range a derivative contract is permitted to trade in any one daily session. Daily trading limits are established by the exchange to protect against market manipulation.
Explanation
The allowable price range a derivative contract can trade is referred to as its daily trading limit. These limits apply to both futures and options contracts. If a contract reaches either the minimum or maximum limit, it cannot be traded until the next scheduled trading day. Daily trading limits were created to limit extreme volatility, which can be detrimental to a market that relies on leverage.
While some analysts believe daily trading limits help to control the volatility in a market and increase investor confidence, others believe these limits create an artificial barrier to the market's true valuation of the derivative. Organizations such as the Chicago Board of Trade are responsible for establishing and maintaining daily trading limits for the various contracts traded on their exchange.
Example
Let's say an exchange establishes a daily trading limit of $0.40 per bushel of corn and the current contract price for a bushel of corn is $3.70. If the price of a bushel of corn for this contract falls to $3.30 ($3.70 - $0.40), or increases to $4.10 ($3.70 + $0.40), then trading is immediately halted on that contract until the next trading session.
Related Terms
The term differential refers to the allowed flexibility to change the quality of the underlying asset in a futures contract. Differential allows the seller in a futures contract to deliver the underlying asset which adheres to a predetermined range of quality specifications.
Moneyzine EditorNovember 6th, 2024
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The term default refers to the failure to meet an obligation on a loan or futures contract. Default occurs when a debtor fails to repay the interest and / or principal owed a lender.Moneyzine EditorNovember 6th, 2024
The term currency risk refers to the relative change in the valuation of two currencies and the impact it has on return on investment. Both investors as well as businesses that own assets in countries with different currencies are exposed to currency risk.Moneyzine EditorNovember 6th, 2024
The term credit derivative refers to an agreement that moves credit risk from one party to the other. Credit derivatives were originally used by participants in the banking industry to diversify the credit risk of customers in their lending portfolio.Moneyzine EditorNovember 6th, 2024
The term closing range refers to the high and low price at which trades occurred at the close of the exchange. The closing range would include both bid and offer prices.Moneyzine EditorNovember 6th, 2024
