A futures or commodity market is a “locked limit” when trading is suspended due to prices moving the exchange-stipulated daily limit. This can happen for one day (it can even lock-limit and then trade-off), or if given a news event monumental, the market may stay “locked” for as many days as needed for market participants to come to an equilibrium. If you trade futures and commodities and you have experienced a locked limit market, it can be either one of the best days of your life (if you’re on the right side) or a complete disaster (E.g., Sept. 11th or the Spotted Owl in 1993 for the Lumber market). It can become a stark reality when prices open above or below your protective stop-loss price, and due to trading being suspended, your position cannot be liquidated. Again what is even more vexing is the uncertainty about your possible exit price since there is no way to tell when and at what price the market will re-open.
The important thing is to know how to protect yourself and avoid financial disaster if you are caught on the wrong side of a locked limit move. Is there a way to do this? Fortunately, there is.
Safeguarding Against Financial Disaster
If this happens to you, always remember that options on futures are not affected by limit moves in the underlying futures (obviously, options will move in price, but they are not frozen). Given this scenario, a trader should immediately use the options market to create a “synthetic futures” position, which will neutralize any further damage to the trader by the underlying futures position.
For example, if a trader is long Cattle futures and the market is locked limit-down against them, they might want to create a synthetic “short” futures position. This would entail buying a Put option and selling a Call option at the same strike price and expiration on Cattle futures, and vice-versa. If stuck in a limit-up move, they would buy a Call and sell a Put at the same strike price and expiration.
Once this “synthetic futures” position is initiated, it offsets the traders underlying futures position. The trader has no more risk no matter what happens from that point forward and can now sleep at night. They will be locking in a loss. However, any potential loss that could be suffered in more closed-limit sessions has been mitigated by an equal profit in the options market.
Questions?
If you have questions regarding the futures markets, would like daily support and resistance emailed to you, or would like to discuss an investment in the future markets, feel free to call me at 312-561-3145 or email info@iasg.com. You can also reach us through our website at www.iasg.com and view our database featuring over 500 CTAs.