Price limits, the levels that securities values are allowed to rise or fall in a day, have direct effects on price changes and margins.
Specifically, the daily price limit is the maximum price advance or decline from the previous day’s settlement price, permitted during one trading session, as fixed by the rules of an option or futures exchange.
Once controversial, price limits have become part of the landscape. Theorists still debate whether such regulations have the desired effect of curbing mob psychology and allowing the markets to cool off rather than move prices beyond fundamentally rational bounds.
Effects on Price Change
The limits are stated in terms of the previous day’s closing price plus or minus a fixed quantity of dollars or cents per unit.
Once a futures price has increased (decreased) by its daily limit, there can be no trading at any higher (lower) price until the next trading day. CBOT’s daily limit for a com, for example, was currently $0.20/bushel, and the previous day’s settlement price was $2.36 (236’0 by CBOT’s conventions), trading will be suspended for the remainder of the day at any price greater than $2.56 or less than $2.16. The following day, it can again move by $0.20/bushel.
In some futures contracts, the limit may be expanded or removed during a trading session for a specified period of time.
This could occur after the contract is at a “locked limit,” the price that has advanced or declined the permissible limit during one trading session, according to exchange rules.