Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
Published on 17 March 2023
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What is the Lot Size In Futures & Options?
A lot size in the futures and options refers to the minimum size of the underlying asset that you can trade in the derivative market. Therefore, while you trade on futures or options, you will buy or sell the products based on the minimum lot size or multiples of the defined lot size. For instance, Reliance Industries Limited has a lot size defined as 250. Therefore, you can only trade the RIL futures and options as a multiple of 250.
Why is Lot Size Necessary in Futures And Options Trading?
Futures and Options contracts are standardised in the derivative market. It is unlike the forward contract that happens Over-the-Counter. And one of the most important ways to standardise a contract is by defining the lot sizes.
To understand it better, let us consider a seller who wants to sell a specific quantity of shares which is slightly odd in number. There is an issue when there are no buyers for the quantity of mentioned shares. The stock exchange can handle such issues by standardising the purchase and sales of shares based on a minimum lot size or multiples of the lot size.
How is the Lot Size Fixed in The Futures And Options Contract?
To understand lot size and how it is fixed, you must know that the futures and options contract is standardised based on size by fixing the notional value, the product of size, and the price. Therefore, the notional value is different from the actual payable margins. It is a fraction of this calculated notional value.
Initially, SEBI had fixed ₹2 lakh as an indicative lot size. Then, the lot size of the individual stocks or indices would be fixed based on the relevant number of shares, which gives a notional value of above ₹2 lakhs when multiplied by the current market price. It was the procedure to fix the lot size until 2015.
In 2015, SEBI decided to check speculation further as the retail investors were not conclusive about the risk involved in the futures and options trading. Therefore, the SEBI increased the indicative lot sizes to above ₹5 lakhs to discourage participation.
The Futures and Options list is getting modified with the inclusions in the range of notional value between ₹7.5 lakhs and ₹10 lakhs. If there is a sharp divergence of the lot value from this range, then SEBI will further review and modify the lot size.
Why Does SEBI Modify Lot Sizes?
The lot sizes are decided based on the indicative lot size defined by the SEBI. However, the indicative lot size can change when there is a sharp increase or decrease in the stock price. For instance, a stock with a defined lot size of 1000 and ₹700 will have a notional value of ₹7 lakhs. If the stock price increases from ₹700 to ₹1400, the notional value will change to ₹14 lakhs. Such an increase will make it difficult for the traders to invest and pay the margins, affecting liquidity.
In the case of stock price correlations, the reverse logic applies. SEBI will increase the lot size to make it more compatible based on the indicative lot value. As the indicative lot sizes are fixed, the individual lot sizes have to be modified and reviewed based on the market price fluctuations of the particular stock or index. Therefore, it is reviewed and fixed on a routine basis.
The lot size of a stock with a higher price will have a smaller lot size, and stock with a lesser price will have a larger lot size. And, the notional value of both the types of stock will be closer in range, and that becomes the standard for trading in Futures and Options.
Conclusion
Lot size defines the minimum quantity for purchasing futures and options contracts. A trader can purchase the quantity of the specified stock futures based on the lot size or the multiples of the lot size. It is introduced to standardise the basis of the futures and options contract.
SEBI regulates, reviews, and modifies the lot sizes based on the price movements. It is done predominantly to discourage traders with limited understanding who get involved and make losses in the derivative market. Hence, educate yourself on the concepts or get assistance from brokers to earn profits in the futures and options contract!
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
What Do You Mean by Leverage & Payoff in Futures & Options?
Derivatives have built-in financial leverage, the source of power that underlies derivatives trading. Leverage encourages investors to invest money and create wealth in the finance world. Appropriate use of financial leverage can be a means of increasing wealth. Futures trading uses leverage extensively to create wealth for investors.
While trading in derivative contracts such as futures and options can be risky but rewarding at the same time, this is why these types of trading are suitable for traders who have experience and who know the market in and out.
The prices based on the lot sizes are available on the trading terminals and the NSE website. You can view the specific price of the futures contract by defining the stock and the type of contract, whether a near, mid, or far month, to get the futures contract price.
The common expiry of the futures and options market on the last Thursday of the month, the 1,2, and 3-month tenure, and defining the lot sizes are the measures taken to standardise the futures contract.
Inexperienced retail investors with limited understanding jump into futures and options, creating excessive losses. Moreover, it has affected their risk appetite to a great extent. Therefore, SEBI regularly determines the lot sizes for only experienced traders to trade in the financial market to make profits.
The stock price and the number of shares required to get the nominal lot value in the range between 7.5 lakhs and 10 lakhs will decide the exact lot size.
Related Articles
What is Futures Pricing & How to Calculate it?
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
What Do You Mean by Leverage & Payoff in Futures & Options?
Derivatives have built-in financial leverage, the source of power that underlies derivatives trading. Leverage encourages investors to invest money and create wealth in the finance world. Appropriate use of financial leverage can be a means of increasing wealth. Futures trading uses leverage extensively to create wealth for investors.
While trading in derivative contracts such as futures and options can be risky but rewarding at the same time, this is why these types of trading are suitable for traders who have experience and who know the market in and out.
The prices based on the lot sizes are available on the trading terminals and the NSE website. You can view the specific price of the futures contract by defining the stock and the type of contract, whether a near, mid, or far month, to get the futures contract price.
The common expiry of the futures and options market on the last Thursday of the month, the 1,2, and 3-month tenure, and defining the lot sizes are the measures taken to standardise the futures contract.
Inexperienced retail investors with limited understanding jump into futures and options, creating excessive losses. Moreover, it has affected their risk appetite to a great extent. Therefore, SEBI regularly determines the lot sizes for only experienced traders to trade in the financial market to make profits.
The stock price and the number of shares required to get the nominal lot value in the range between 7.5 lakhs and 10 lakhs will decide the exact lot size.
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