Market Matters Blog
Katie Micik DTN Markets Editor

Wednesday 03/19/14

CME Shifts to Variable Daily Limits

OMAHA (DTN) -- The daily limits on how far grain futures contract prices can move each day will be reset twice a year according to a new formula, CME Group announced on Wednesday.

CME Group's proposed new variable price limit mechanism will allow higher limits when futures prices are high and lower limits when prices are low. (DTN file photo by Jim Patrico)

The new variable price limit mechanism will allow higher limits when prices are high and lower limits when prices are low. It replaces the current fixed limits of 40 cents per day in corn contracts and 70 cents per day in soybean contracts.

The variable limits, which must be approved by the Commodity Futures Trading Commission, are scheduled to go into effect on May 1 for all standard and mini corn, soybean, soft red winter wheat, hard red winter wheat, soybean oil, soybean meal, oats and rough rice contracts.

CME will also eliminate daily price limits on all of the grains and oilseeds options products.

Dave Lehman, CME's managing director for commodities research and development, said the variable limits proposal is on track for CFTC's 45-day approval process.

CME last changed limits on futures contracts in August 2011, when it boosted corn's daily limit from 30 cents to 40 cents. CME previously raised corn daily price limits to 12 cents in 1993; 20 cents in 2000; and 30 cents in 2008.

CME began working in a new price limit mechanism after 2011's change. In conversations with customers at that time, Lehman said they heard a lot of concern that the price limits were constraining the market after a recent run-up in prices.

"At the same time, there was interest in a mechanism that would allow limits to contract when prices went down," Lehman said.

DTN Analyst Rick Kment said that when corn was trading in the $2-per-bushel range in 1993, a 12-cent limit would allow a 6% price swing. When corn prices moved to $4 per bushel, the 12-cent limit only let the market go up or down 3% each day.

"In the past, I think CME felt that it had always been playing catch-up because any push to increase limits and maintain the desired percentage market shift has always followed a price movement, and not kept up with the movements," Kment said.

Lehman said there was always a lot to consider when making an "ad-hoc" change to limits, chief among them changing the terms on existing contracts. The new method gives two weeks between when the new limits are set and when they go into effect.

He said customers liked that limits provided a "cooling-off period" on hot market days. "We think this mechanism strikes a balance between cooling off and letting the market function as the price discovery tool it's designed to be."

Under CME's new variable formulation, the daily limit would be set at 7% of the average settlement price of 45 consecutive trading days. It will automatically readjust on the first trading day of May and November each year. The May readjustment will be based on the July contract's settlement prices while the November adjustment will use the December contract for most grains, and the November contract for soybeans and rice.

Lehman said CME arrived at 7% from a statistical perspective: Historically, 99% of price changes in the grain market have been 7% or less.

"So out of 100 days, maybe there's one day with more than a 7% change," Lehman said. So under the variable limit format, "maybe we can expect one or two days of limit moves in a year."

CME also established minimum daily price limits -- 20 cents on corn, 50 cents on soybeans and 30 cents on the wheats -- in case the 7% formula is overly restrictive. The higher of the two calculations will be used as the price limit.

The new variable price limit mechanism allows for expanded daily limits. If the contract settles up or down the limit, the next day's limit will be expanded 50% and rounded up to the next 5-cent mark. For example, if corn futures settle up 25 cents per bushel (in two contract expirations or in the last contract of the crop year), the limit will expand to 40 cents per bushel the next day "and remain at that level until no corn futures contract expirations settle at the expanded 40 cents limit."

If the criteria is met in one of the contracts of the soybean complex (beans, meal or oil), the limits will expand for the whole complex.

HOW VARIABLE PRICE LIMITS WILL BE FIGURED

CME's mechanism for figuring variable price limits aims to keep the market from swinging more than 7% in one day. When prices are higher, the limit will be higher. When they're lower, the limit will drop. This is what would have happened to daily limits if this rule had been in place before 2012's harvest.

From Aug. 13 to Oct. 16 in 2012, the average December settlement price was $7.74. Seven percent of that figure is little more than 54 cents, so the limit would be rounded up to 55 cents. It'd be in place from the first trading day of November to the last trading day in April.

CME would begin tallying the July 2013 contract's price around Feb. 11 and would calculate the average on April 16. Last year, the average settlement price would have been $6.73, resulting in a 45-cent daily price limit.

During the fall of 2013, the average December settlement price from Aug. 13 to Oct. 16 was $4.59. Seven percent is 32 cents, which would be rounded down to a 30-cent daily price limit.

"If you look at prices now, the corn limit would probably go down (from the 40-cent fixed limit), and the soybean limit would probably go up (from the 70-cent fixed limit)," Lehman said.

Katie Micik can be reached at katie.micik@dtn.com

(AG/BAS)

Posted at 7:59AM CDT 03/19/14 by Katie Micik
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