The USDA Crop Report out today is causing spikes higher in the grain complex, with Corn limit up (+30¢) on the news that corn stocks are at their lowest levels since the mid-1990s. The US is currently sitting on what amounts to two weeks of corn in reserves. (Yikes)
We often get questions from investors about what sort of risk controls are in place within managed futures programs and trading systems to protect against catastrophic losses if stuck on the wrong side of a limit up/down move. As a reminder, limit moves are when trading activity is halted by the exchange at a pre determined level (in the case of Corn, an up or down move of more than 30¢ – the equivalent of about a 500 point move in the Dow)
Most managed futures programs and trading systems protect against limit move damage by controlling how much they risk on any one trade. The average risk per trade for a typical CTA is around 1.0% of equity. That means a $250,000 account would be risking $2,500 on a single trade. With the 50 day average true range of Corn about 21¢, or $1,050 (21*50), the typical CTA would taking on about 2 contracts on a Corn trade ($2,500/$1,050 = 2.4).
So, how big of a loss would a typical CTA short Corn on today’s limit up move be looking at? Likely just $3,000 [2 contracts times $1,500 per contract ($50/cent contract value * 30cent move)], or just 1.2% of equity. Not something you want to lose every day, to be sure, but also not the catastrophic type of loss most investors fear when hearing about limit moves.
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