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A lock limit is a situation associated with the prices of a futures contract. When this type of limit takes place, the current trading price for the contract reaches a level that is equal to the limit price currently recognized by the exchange in which the contract is traded. Once a lock limit has been identified, the trading activity within that exchange will exclude any offers that are greater or less than that lock limit associated with that futures contract.
Key to the creation of a lock limit situation is the limit price that is determined by the exchange. Most exchanges will use several criteria to set this type of pre-determined price, including the financial stability of the underlying entity that issues the contract. The establishment of a limit price is actually to the benefit of investors, since it helps to minimize the amount of loss that investors may incur on futures contracts.
Typically, a lock limit is imposed for a single trading day only. This means that if on a Monday, the trading price on a futures contract jumped from just below the exchange’s limit price to slightly above that price, it would not be allowed to slip back below that limit price for the remainder of the day. In like manner, if the trading price slipped below the limit price set by the exchange, any further orders that were below that limit price would not be executed for the rest of the trading day. Whether or not a lock limit would occur the next trading day would depend on how the trading prices compared with the limit price associated with that futures contract. In extreme situations, a lock limit situation may be recognized for several successive days, based on what happens with the attempted trades of that contract on each of those days.
One of the benefits of a lock limit is that it creates some level of protection for investors who are engaged in the trading of futures contracts. Owing to the level of risk associated with this type of investment, the potential to sustain losses is significant. By establishing some sort of limit price, an exchange provides investors with one more tool to use in assessing the viability of buying or selling the futures contract in question, a move that not only aids investors but also helps to keep the trading on the exchange brisk and somewhat balanced.
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