Musings On The True Reason For The CME's Increase In Daily Corn Trading Limits
With stock volatility having morphed over the past year to FX and commodities, along the lines of what had been expected, some of those trading various ags (and other commodities) have had to literally suffer through days of gutwrenching market halts when a given product hits its daily limit for the day. And over the past two months it has been a veritable limit-a-palooza. Which is why we were not surprised to learn that having appreciated the severity of this artificial "limit" rule, the CME is now considering its revision. From Reuters: "The CME Group Inc is considering widening the daily trading limit in Chicago Board of Trade corn futures to 50 cents per bushel, from the current 30 cents, a spokesman for the exchange said Tuesday...The exchange last expanded the daily limit in corn in March 2008, to 30 cents from 20 cents. At that time, front-month CBOT corn futures <Cc1> were trading at $5.60 a bushel and were on their way to a then-record high of $7.65 in June 2008." And since, pretty soon the new, wider range will likely be filled on a daily basis when the market goes all bid or offered, we expect the CME to do away with position limits entirely: a progression diametrically opposed to what the SEC is doing to halt market crashes in regular equity markets. It is almost as if the CME is inviting more volatility into a market (where the exchange makes the bulk of its money based on daily traded vol). But is there more here than meets the eye?
That peak price was surpassed this month as front-month corn reached $7.83-3/4 on concerns about extremely tight supplies. The U.S. corn supply is forecast to drop to 675 million bushels by Aug. 31, the smallest amount measured as a percentage of usage since the 1930s.
Once a futures contract rises or falls by the daily limit and stays there, trading stops. At that point, the only way to trade the market is through options, in moves that create synthetic futures positions.
In 2008, the move to widen the daily limits for grains followed several consecutive days of limit-up or limit-down moves, fueled by tightening global grain supplies and rising speculative interest in commodities.
Now, analysts said CME wants to head off that scenario. They said the exchange appears to be preparing for more volatility as the growing season for the next U.S. corn crop unfolds.
Preparing? Or Welcoming? And how long until the CME launches limit knock out derivatives? After all, why let a possible bet go to waste?
"I'd say they are trying to be a little proactive, looking at the potential for some volatile trade if we were to have a drought situation develop or something like that," Prudential Bache Commodities analyst Shawn McCambridge said.
"It is more orderly to allow the market to trade and discover the price, rather that go limit the first thing in the morning," McCambridge said.
With tightening stocks of old-crop corn, the futures market has been even more sensitive than usual to weather threats that could reduce yields in the U.S. Corn Belt. Planting is already behind schedule due to wet conditions in much of the Midwest.
Nevertheless, higher daily limits could pose a challenge for grain elevators and other commercial grain users that hedge their inventories by selling corn futures to offset the risk of falling cash prices.
These players could face higher margin calls if a spike in the market, compounded by a wider daily limit, caused a loss in their short futures position.
"The limits they have now seem to be working, and I think going to 50 cents would be a mistake," said Harry Bormann, grain team leader with MaxYield Cooperative in West Bend, Iowa.
"Higher limits mean we have to margin more.... It's going to be a cost to us," Bormann said.
Ah, and there you have it: by inviting not only more vol (read bottom line for the business) but more margin, the CME is exposing speculators to far greater impacts from margin hikes (and drops). Which of course means a far great capacity and ability to kill any commodity rally dead in its tracks. Because if current margin hikes are failing, a topic exposed previously on Zero Hedge, the CME has realized it will certainly need a bigger mousetrap, and far greater visions of overnight fame and fortune.
Expect to see this move followed in all other major commodities.
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