V.8:9 (336-336): Trading Limit Markets by Douglas Arend

V.8:9 (336-336): Trading Limit Markets by Douglas Arend
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Product Description

Trading Limit Markets by Douglas Arend

In an effort to maintain orderly markets in commodity futures, many exchanges impose daily trading limits. If prices rise above or fall below the previous session's close by a certain amount, further movement in the same direction is prohibited throughout the remainder of the session. The theory behind the use of limits is to afford an opportunity for markets to pause while participants determine if a move is overdone.

Regardless of the underlying arguments for trading limits, such restrictions can be very frustrating to traders who find themselves locked into a position with the market limit against them. Prior to the introduction of commodity options, the only recourse for such traders was to establish a spread position using either another delivery month or a commodity that was still trading. At best, this was often a poor substitute for being able to close the futures position directly.

Commodity options give traders the opportunity to create synthetic futures positions that parallel the behavior of the underlying contract. One advantage of this strategy is it allows positions to be traded, even when a market is locked limit.

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