Market Matters Blog

Intuitive, with the Potential for Confusion

CME Group outlined its new mechanism for setting daily price limits on the grain markets. One of our editors saw a tweet and asked: What does this mean, and do we need to tell people about it?

The answer from our Senior Analyst Darin Newsom was a resounding yes, followed by a technical description of how the new method would work. But while Newsom answered in wonderful detail, I think the editor's question was just as revealing.

Not every DTN reader (or every DTN staffer) understood what this headline said at first glance. They've probably heard of days where the market has locked limit-up or limit down, but it's probably not the first thing they thought when they saw CME's announcement. I'd bet "Huh?" was a more realistic reaction.

Even remembering the fixed price limits can be hard. Currently, it's 40 cents on corn, 70 cents on soybeans and 60 cents on wheat. I had to ask our analysts to remind me of the wheat limit.

I think CME's variable price limit mechanism is intuitive and will work well for the market, but there's also plenty of potential for confusion.

At its core, CME Group is moving from an "ad-hoc" system of adjusting fixed daily price limits to a fluid system that's responsive to the markets. When CME changed the limit for corn in 2011, they were criticized for being behind the curve. Prices had already risen, and traders felt the 30-cent limit restricted the market on its upswing. Others felt it'd be hard for CME to reduce the limit when prices swung lower, given its tortoise-like approach to increasing the limit. After all, the corn limit only changed four times since the 1990s.

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CME's taken themselves out of the equation with their new mechanism, which will reset the daily limits twice a year on the first day of May trading and November trading. The exchange will average the price of the July or December futures contract over 45 days, multiply it by 7% and round the answer to the nearest nickel.

"For example, instead of a standard 40 cent daily price limit for corn, it would be a variable amount depending on price. If the six week average for July corn was $4.50, times 7%, equals 31.5 cents. Rounded to the nearest 5-cent increment would be 30 cents. In contrast, if July corn closing prices averaged $6.00, 7% would be 42 cents that would round to 45 cents," Newsom said.

Joe Hofmeyer, a market analyst at CHS Hedging, said that overall it's not a huge change, but it's one that could increase flat price volatility and could create confusion among commercial grain traders' customer base. Hofmeyer's thoughts:

"Overall I don’t think it’s a big deal, although it does have the potential to increase flat price volatility in the futures market if the markets can justify it. Allowing limits to move proportionately to the futures market (with 6 month increments) should create cleaner/more transparency if the market can justify limit expansion through higher prices. Right now on lock limit days the big players with a certain level of sophistication can simply move over to synthetic options and continue to trade. It is interesting to do the math and see the that in order to maintain our current 40 cent limit in corn we’ll need a 6 month average in July 14 corn futures of $5.72 (no way we get to that), so it seems that limits will actually shrink. Intuitively it makes sense the limits should be proportionate to the futures market in which they are limiting, this is how option values work.

"From the commercials perspective, specifically, I do think that it will create some confusion with their customer base. I get questions all the time from producers wondering what the limits on corn, soybean and wheat are. Imagine how much additional confusion there will be when these limits are moving every 6 months."

Here are a few resources to help you be minimally confused. The new limit scheme will go into place on May 1, using the 45-day average from mid-February to April 16. It will change again in November, just about in time for you to forget it all again. I've got your back on that one though; I've already put a reminder in my calendar to write a blog next fall when the limit changes again.

Here's a link to CME's executive report, which outlines the changes in detail.…

The information below is from the DTN article published last Friday. Essentially, it's just walking you through the math using the past year and a half of prices as an example.


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 in corn 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.

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