38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
658 Part V: Index Options and Futures
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tracts in order to help ensure that the market cannot be manipulated by someone
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forcing the price to move tremendously in one direction or the other. Another rea
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son for having trading limits is ostensibly to allow only a fixed move, approximately
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equal to or slightly less than the amount covered by the initial margin requirement,
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so that maintenance margin can be collected if need be. However, limits have been
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applied to all futures, some of which don't really seem to warrant a limit - U.S.
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Treasury bonds, for example. The bond issue is too large to manipulate, and there is
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a liquid "cash" bond market to hedge with.
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Regardless, limits are a fact of life in futures trading. Each individual commod
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ity has its own limits, and those limits may change depending on how the exchange
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views the volatility of that commodity. For example, when gold was trading wildly at
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a price of more than $700 per ounce, gold futures had a larger daily trading limit than
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they do at more stable levels of $300 to $400 an ounce (the current limit is a $15
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move per day). If a commodity reaches its limit repeatedly for two or three days in a
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row, the exchange will usually increase the limit to allow for more price movement.
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The Chicago Board of Trade automatically increases limits by 50% if a futures con
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tract trades at the limit three days in a row.
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Whenever limits exist there is always the possibility that they can totally destroy
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the liquidity of a market. The actual commodity underlying the futures contract is
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called the "spot" and trades at the "spot price." The spot trades without a limit, of
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course. Thus, it is possible that the spot commodity can increase in price tremen
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dously while the futures contract can only advance the daily limit each day. This sce
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nario means that the futures could trade "up or down the limit" for a number of days
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in a row. As a consequence, no one would want to sell the futures if they were trad
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ing up the limit, since the spot was much higher. In those cases there is no trading in
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the futures - they are merely quoted as bid up the limit and no trades take place. This
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is disastrous for short sellers. They may be wiped out without ever naving the chance
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to close out their positions. This sometimes happens to orange juice futures when an
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unexpected severe freeze hits Florida. Options can help alleviate the illiquidity
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caused by limit moves. That topic is covered later in this chapter.
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DELIVERY
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Futures on physical commodities can be assigned, much like stock options can be
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assigned. When a futures contract is assigned, the buyer of the contract is called upon
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to receive the full contract. Delivery is at the seller's option, meaning that the owner
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of the contract is informed that he must take delivery. Thus, if a corn contract is
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assigned, one is forced to receive 5,000 bushels of corn. The old adage about this
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being dumped in your yard is untrue. One merely receives a warehouse receipt and |