In a July 19, 2011, meeting held in Chicago and on the Web, staff from the CME Group, owners of the Chicago Board of Trade (CBOT), explained to the industry why they amended their original proposal to increase existing corn limits.
Originally, the CME submitted a proposal to the Commodity Futures Trading Commission (CFTC) to increase the daily price limit in CBOT corn futures from the current 30 cents per bushel, which is expandable to 45 cents, to 50 cents per bushel. If the 50-cent limit were hit, the limit would expand to 75 cents, and if that limit were hit, it would expand again to $1.10 per bushel.
Customer concerns during an ensuing comment period prompted the CME to submit on May 10, 2011, an amended proposal to scale back the proposed increase in the limit to 40 cents per bushel expandable one time to 60 cents. Options limits would also increase. The two main industry concerns that prompted the scaled-back proposal, according to the CME, were that expanded limits cause volatility and raise the margin requirements. A margin requirement is the amount of capital a hedger or speculator must have on account.
"The CFTC does not require us to have price limits on our contracts," said Fred Seamon, associate director of commodity research and product development for the CME Group. "For contracts with price limits, we are obligated to set those limits at levels that do not disrupt either the futures market or the cash market."
Volatility not driven by price limits
Seamon made a convincing argument using data collected since the early 1990s that each time the daily limit was raised on corn during a period of high volatility, the margin requirement increased immediately but then fell back within a month once volatility decreased.
For instance, he said that in 1993 in a period of exploding volatility, the hedge margin requirement increased from 4 cents to 10 cents when the daily limit was expanded from 8 cents to 10 cents per bushel. "It stayed there one month, until volatility fell back to normal levels," Seamon noted. While the margin requirement did not return to pre-expanded limit levels, it dropped back to 6 cents per bushel.
In 2008, another period of extreme volatility, the margin requirement rose from 20 cents to 30 cents when the limit was raised from 20 to 30 cents. A month after the new limit was implemented, volatility once again dropped back and the margin returned to 20 cents, Seamon noted. "When volatility is low, we see a drop in hedge margin requirements," he added.
Volatility occurs when the daily limit nears 4 percent of the nearby futures contract price. "Corn limits are low relative to other major commodities," Seamon noted. The 30-cent daily limit in corn was 4.2 percent of the intra-day front-month corn futures prices for July 15. The 70-cent limit on soybeans was at about 5 percent of the intra-day front-month soybean futures prices, while the 60-cent wheat limit was at 8.44 percent of the wheat contract. "Smaller limits mean more contracts settle at the limit," he added.
From the start of this year through July 11, 68 corn contracts settled either limit up or limit down in eight of the 129 trading sessions that occurred. By contrast, only nine soybean and five wheat contracts have closed either limit up or down over the same time period.
Fixed versus changing limits
Other ideas the CBOT might consider include setting limits each day based on a percentage of the spot market price, setting limits quarterly based on a percentage of the spot settlement price in the last day of the previous quarter, or implementing circuit breakers, where trading is halted for a period of time once a contract’s limit is reached and then reopened with a new price limit.
Volatility, not the daily limit, drives margin requirements, said Ann McCormick, director of market risk management for the CME Group. Currently the margin on corn is 35 cents per bushel, above the daily limit.
"We are concerned about market efficiency and market performance," said David Lehman, managing director of research and product development for agricultural commodities for the CME Group. Problems start to occur when the limit is about 4 percent of the futures price or lower; the market locks up and price discovery becomes impossible.
"From an economist’s perspective, I’d rather see limits based on a percentage of price," said Lehman. "Having a fixed number as a limit is problematic." However, it is easier to understand and implement and easier for the clearinghouse to handle. He argues that an expanded daily limit will not require hedgers to have more capital in their accounts over the long-term but may require more capital over a two or three day period.
The CME will take comments on its proposal on raising the corn limit until August 8, 2011.