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Locked-limit panicked trader?
photo: artemuestra@flickr
Every prudent trader will ensure they minimise their risk by placing stop-loss orders where they should get out of the market. This is one of trading basic truths:
Cut your losses short.
However there is one case where the Futures market will not let you exit at any price: when the market is locked-limit.
Locked-Limit
Most Futures market have a defined daily limit for price moves, at which point trading is suspended. The market is said to be locked-limit (either up or down). As a trader, the move might go against a position you have in the market and possibly right through your stop-loss – without any way for you to exit your position.
Your main concern should be to try and contain the loss as best as possible (markets can go limit-up or limit-down for a few days in a row – and possibly decimate your account in the process!)
Surviving Locked-limit markets
One option is to offset the Futures transaction in the Cash market. However for most traders, it is not practical or possible to deal with the Physical Commodity…
Synthetic Futures contracts to the rescue:
A “lighter” way to implement an offsetting the Futures position is to trade an equal and opposite position by creating a synthetic Futures contract using options.
To hedge a short futures position a synthetic long futures can be employed: this options strategy simulates the payoff of a long futures position (unlimited profit, unlimited risk) by combining the buying of at-the-money call options (limited risk, unlimited profit) and the selling of an equal number of at-the-money put options (unlimited risk, limited profit) of the same underlying futures and expiration month.
To hedge a long futures position, the reverse can be employed (synthetic short futures by selling call options and buying put options).
These are solutions for extreme cases… where it pays to be prepared with a plan in mind.
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