Lock Limit: What It Is, How It Works, Example

What Is a Lock Limit?

A lock limit is a specified price movement determined by an exchange that, if breached results in a trading halt of that instrument beyond the lock limit price. "Lock limits" typically refer to the futures markets, with the related terms "curbs" or "circuit breakers" used in the stock markets.

Lock limits help regulate markets and keep them more calm and orderly. Traders may still be able to transact at the lock limit price, or inside of it, but trading is halted outside of the lock limit price. Lock limits halts may be temporary, such as five minutes, or they may be in place for the day. Each futures contract has lock limit specifications attached to it.

Lock limits are relatively uncommon in practice and may be regulated and instituted differently among different exchanges.

Understanding a Lock Limit

Lock limits are used across exchanges to regulate the volatility of trading instruments. They are used in futures markets, as well as stocks, although in the stock market the term circuit breaker is more common. The concept is the same.

Lock limits are in place at all times and are applied to both upside and downside moves. For example, if the limit on corn is $0.25, then a $0.25 move up or down from the prior close will trigger a lock. If the price has dropped, trading will not take place below the lock limit. This is called limit down. If the price reaches the upper limit, the futures contract is limit up. When this occurs, trading can't occur above this level during the lock.

Depending on the futures contract, trading may be halted entirely during a lock limit, or only inside the lock limit price. For example, if the price is limit down, a big buyer could step in and buy from the sellers at the lock limit price, and then bid the price up to push the price away from the lock limit. Trading would then occur as usual as long as the price stays above the lock limit. In other cases, the futures contract may be suspended for the day once the limit is reached.

The next day, another lock limit price would be instituted, and trading can resume up/down to the next lock limit price.

How Lock Limits Work

Commonly associated with the futures market, a lock limit occurs when the contract price of a commodity instrument moves beyond its allowable limit. When this occurs, trading stops for the day beyond that price. Limits can be limit up or limit down.

For example, consider soybean meal trading last closed at 300. The lock limit is 20, subject to change. That means that a single-day move to 320 or 280 would trigger the lock limit. If the market goes limit up, trading can't take place above 320. If the market does limit down, trading can't take place below 280.

Some futures also have expanded or variable limits. This means that if multiple contracts, for different months, go limit up/down, then the next day the limit is expanded. In the case of soybean meal, the expanded limit is 50%, which increases the limit the next day to 30. If the market was limit down at 280, the next day the limit down price will be 250 and the limit up price 310. The limit stays at the expanded rate if the price goes limit up/down again, but contracts back to 20 if the expanded lock limit isn't hit.

Real World Example of a Lock Limit

Assume a lumber trader wants to know what the limits are based on the current price, as a major news announcement is due out today. Based on the current price, the limit is 19, which is subject to change over time, but at the time of the trade is 19.

Assume that lumber is trading is 319. That means the upside limit price is 338, and the downside limit price is 300.

Lumber also has an expanded limit of 29. This too is subject to change, but at the time of the transaction, the expanded limit is 29, which means that this limit will come into effect tomorrow only if lumber settles at the limit up or down price today.

Assume the trader is interested because they own lumber futures at 310.

The news is bad and the price immediately drops to 300. The market is now limit down, and trading doesn't take place below this. This also means the trader can't get out of their position. They can try to sell at 300, but they are unlikely to find buyers. If they do, then the price may be starting to move up and away from the limit down price.

If contracts for different months settle limit down, the next day the new limit is 29. That means the new limit down is 271 (300 - 29). The price opens at 290 and our trader is able to get out of their position with a loss.

If the market continues to drop and settles at 271, the expanded limit remains in effect, and the next day the limit down is 242 (271 - 29). If the price settles above 271 (and below 329) then the expanded limit hasn't been triggered and the 19 limit is reinstituted above and below the closing price.

Other Financial Uses of the Term "Lock"

Other types of locks also appear in the financial world:

• A loan lock is when a specified interest rate is held for a customer by a lender for a specific lock period.
• A mortgage rate lock float down holds a specified interest rate for a loan with an option to decrease the rate if broad market rates fall.
• A Treasury lock is an agreement to lock in a specified rate. Usually executed as a derivatives contract for a specified period of time.
• A lock-up agreement is a contractual provision preventing insiders of a company from selling their shares for a specified period of time. They are commonly used as part of the initial public offering (IPO) process. Lock-up periods typically last 180 days, but on occasion can be as brief as 90 days or as long as one year.
• Locking in profits refers to the realization of previously unrealized gains accrued in a security by closing all or a portion of the holdings