Markets

Markets

Limit Up, Limit Down

A couple of devices that major exchanges use to stop manipulation or extreme volatility in the markets are called "limit up, limit down."

What is Limit Up?

This is the maximum amount by which the price of a commodity futures contract may advance in one trading day.

Simply put, it's the top price a contract can be traded before an exchange would stop its trading.

The exchange sets this highest limit at what it thinks would be a price that would cause manipulation or volatility. The price varies from commodity to commodity.

Some markets will allow the contracts to resume trading if the price moves away from the day's limit.

What is Limit Down?

Just the opposite of limit up, this is the maximum amount by which the price of a commodity futures contract may decline in one trading day. So it's the lowest amount a commodity can be traded before an exchange halts trading.

Like limit up, the exchange sets the lowest limit at what it thinks would be a low price that would cause manipulation or volatility. The lowest price varies from commodity to commodity.

And also like limit up, if the contract prices do go higher away from their limit down, exchanges will allow trading to resume.

How do limit up, limit down work?

Say that corn futures have a price limit of 30 cents for the day. Suppose corn closed at $3.30 the previous day. The corn futures can only trade as high as $3.60 or as low as $3 during the day's trading session. No orders can be filled outside of those limits.

When were limits first used?

Limits were created in 1988 and percentage move limits have been used since 1998.

Limits are calculated after each quarterly expiration of a futures contract based on the average closing price for the contract.

What are commodities?

Usual examples of commodities are grains, gold, beef, oil and natural gas—but the definition has expanded to include financial products such as foreign currencies and indexes. The sale and purchase of commodities is usually carried out through futures contracts on exchanges.

Commodity futures contracts have a final date by which the contract must be delivered in order for the terms of the contract to be fulfilled.

What is the difference between limit up, limit down and circuit breakers?

As we've said, limit up, limit down would let commodity futures contracts trade within set boundaries, but stop if prices stray beyond them.

Circuit breakers , on the other hand, are a market safety feature and temporarily stop trading when there is a computer-induced plummet in prices. This occurs when the market has fallen by a certain percentage point set by the exchange.

The major difference between the devices is that circuit breakers would be used to stop trading across the whole exchange—while limit up, limit down are confined to futures contracts and happen quite often during a trading day.

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Exchange-Traded Notes - ETN

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Exchange-traded notes, or ETN's, are a relatively new type of investment, but growing in popularity.

What are ETNs?

They are an unsecured debt security, usually issued by an investment bank. It's important to note they are unsecured and not guaranteed by the issuer.
Financial institutions like JP Morgan Chase, UBS, and Barclays offer ETNs. In fact, Barclays was the first to ever offer ETNs in 2006.
The purpose of ETNs is to create a type of security that combines both the aspects of bonds and exchange-traded funds (ETF). But ETNs do not have stocks or any other equity product.

What is an ETF?

An ETF is a security that tracks an index, a commodity, or assets such as an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

What are the similarities and differences between ETFs and ETNs?

Like ETFs, ETNs are traded on major exchanges, such as the New York Stock Exchange, during normal trading hours. Like ETFs, ETNs can be bought and sold during normal trading hours on the exchanges.When you buy an ETF, you're buying a slice of a diversified portfolio of stocks. But when you buy an ETN, you're buying a promise of a debt payoff — specifically, the promise that the issuer will pay the note according to the terms laid out in the ETN's prospectus.

The promise is just that — a promise. As mentioned above, there's no guarantee of payment and no current regulation forcing one.

Investors can hold the debt security until maturity. At that time, the issuer will give the investor a cash amount that would be equal to principal amount — minus any related fees and commissions. Unlike ETFs, holders of ETNs pay no interest or dividend distribution, which means there is no annual tax. Capital gains — or losses are realized when an investor sells the ETN, or when it matures. One factor that affects an ETN's value is the credit rating of the issuer. The value of the ETN may drop despite no change in its underlying asset. That drop in value would come from a downgrade in the issuer's credit rating.

What's an example of an ETN not paying off?

One only has to look at the collpase of Lehman Brothers in September 2008. Lehman's ETNs — which were marketed for less than a year — had little in the way of assets beyond their seed capital.