Keeping Corn Markets Operating Efficiently

In recent months, historically low levels of supply coupled with growing demand for corn and other macroeconomic factors have resulted in significantly increased corn futures prices and volatility.

As a result, an increasing number of CBOT corn futures contracts have experienced trading disruptions due to price limits. In light of this volatility – to ensure they provide price discovery and risk management – CME Group is proposing to increase the daily price limits in CBOT corn futures from 30 cents per bushel per day to 40 cents per bushel per day. The price limit in corn futures and options represents the maximum price movement allowed in a single trading day.

Too many corn futures contracts have been hitting their daily price limit resulting in the loss of price discovery, transparency, and risk management in the futures market. Through mid-July 2011 alone, 68 corn contract months have settled at or above the initial price limit of 30 cents, compared to 36 corn contract months settling at or above the initial price limit in all of 2010. At the same time, front-month corn futures settlement prices have reached numerous records, including the current high of $7.87 per bushel set on June 10.

CME Group will hold a meeting on Tuesday (July 19) to discuss the proposed increase to daily corn price limits. All corn industry participants are invited to attend.

The current price limit of 30 cents per bushel is only 4.23 percent of current futures prices, which is historically low, and this is preventing the market from performing its intended functions of price discovery and risk management when trading is halted because of limit price moves. In comparison, initial price limits in soybean futures are just over five percent of current prices and in wheat futures initial price limits are over eight percent of current prices. Consequently, soybean futures have seen only nine contracts settle at or above initial price limits in 2011 and wheat futures have seen only five contracts, compared to 68 in corn futures.

CME Group has received some opposition to the proposed price limit increase. Generally, the argument has been that increasing price limits will result in higher volatility and higher margin requirements. However, a historical look indicates that increased price limits are actually associated with reduced volatility and falling margin requirements – approximately one month after a price limit increase.

We recently published a white paper that explains the situation surrounding corn price volatility and the need to increase daily price limits.

Moreover, when trading is prevented because the daily price limit is hit, the futures contract in question cannot do its job of price discovery. Risk management moves to options and/or OTC markets and price transparency is thus reduced. Essentially, this leads to a less-efficient market, one in which there is far less confidence around prices.

While futures prices have receded slightly in the weeks following the USDA’s June 30 crop report, market participants may see continued volatility throughout the growing season as a result of weather conditions and supply and demand fundamentals. Keeping markets efficient and effective is at the heart of CME Group’s mission, and we remain confident that the proposed price limit increase only stands to help the markets.

Tim Andriesen is the managing director of agricultural commodities and alternative investment products at CME Group.

About the Author

Tim Andriesen is managing director of commodity products at CME Group.

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