Notional value is the contract value of a financial instrument trading on an exchange. This value helps you perceive how much a trade is worth vs. how much you would pay for it right now.
The notional value of a futures contract is calculated by multiplying the units in one contract by its current price.
Key Takeaways
- Notional value is a theoretical value of a financial instrument trading on an exchange.
- The notional value of a futures contract demonstrates the value of the assets underlying the futures contract.
- To calculate the notional value of a futures contract, the contract size (in units) is multiplied by its current price.
- Notional value helps you understand and plan for the risks of trading futures contracts.
Calculating a Commodity Future Contract's Notional Value
To calculate a future contract's notional value, you need to locate the commodity's specs page. The current price of the unit depends on the commodity's tick value and movement, and the contract unit is how many units are represented by the contract. For example, you might see soybeans trading at $13.07 on the Chicago Mercantile Exchange.
Notional Value = Contract Unit x Current Price
So, if soybeans were trading at $13.07, you would multiply the number of contract units (5,000) by the contract price, $13.07. The notional value of a soybean futures contract at this price would be $65,650 (5,000 x $13.07).
A future contract's price is a reflection of how many 'ticks' it has moved. For example, soybean's minimum price fluctuation is $0.0025 per bushel, so the minimum price tick is $12.50 per contract (5,000 x $0.0025).
Why Notional Value Is Important
Notional value is key to managing risk. In particular, the notional value can be used to determine the hedge ratio, which lays out the number of contracts needed to hedge market risk. The hedge ratio calculation is as follows:
Hedge ratio = Value at risk ÷ Notional value
Value at risk is the amount of an investor’s portfolio at risk—or subject to loss related to a particular market. For example, imagine you have a $5 million position in soybeans you would like to hedge against future losses. You would use a futures contract to do so.
Continuing with the soybean futures example from above, it would take roughly 76 of the above soybean futures contracts to hedge your position ($5 million divided by $65,650).
By calculating notional value, you can see what actions you need to take to understand and plan for the risks of trading futures. It may take a small amount of money to buy an option contract thanks to leverage—but movements in the underlying asset price can lead to a large swing in your account.
Futures Contracts and the Market
There are two main participants in the futures markets. Hedgers seek to manage their price risk for commodities, and speculators want to profit off of price fluctuations for commodities. Speculators provide a great deal of liquidity to the futures markets. Futures contracts allow speculators to take larger amounts of risk with less capital due to the high degree of leverage involved.
Futures contracts are financial derivatives with values based on an underlying asset. They are traded on centralized exchanges such as the Chicago Mercantile Exchange (CME) Group or the Intercontinental Exchange (ICE).
The futures market began in the 1850s in Chicago with farmers seeking to hedge their crop production. Farmers could sell futures contracts to lock in a price for their crops. This allowed them to be unconcerned about daily price fluctuations. The futures market has since expanded to include other commodities, such as energy futures, interest rate futures, and currency futures.
Futures Contracts Length
Unlike stocks that can exist in perpetuity, futures have an expiration date and are limited in duration. The front-month futures contract is the contract with the nearest expiration date and is usually the closest in value to the current price.
The price of the front-month futures contract may be substantially different than the contract a few months out. This allows the market to attempt to predict supply and demand for a commodity further out.
What Is Meant by Notional Value?
Notional value is the current value of a futures contract. Because it uses the contract's current price, it changes over time because the contract's price changes.
What Is Notional vs. Actual Value?
If actual value is defined as market value, then notional value is the theoretical value of a position and actual value is how much you'd pay at that moment.
What Is the Concept of Notional Value?
Notional value is the amount a contract is worth at a given moment. It is used to help investors and traders assess risk and manage their positions.
The Bottom Line
A future contract's notional value is it's contract size multiplied by it's current price. It indicates the value of the underlying asset based on quantity and how much it is trading for, which helps you make decisions about a position and trade.
Correction —May 27, 2023: A previous version of this article used the term "spot price" in place of "current price" when referring to calculating notional value.
FAQs
Notional value is integral in assessing portfolio risk, which can be very useful when determining hedge ratios to offset that risk. 2 For example, say a fund has a $1 million long exposure to U.S. equity markets, and the fund manager wants to offset that risk using the E-mini S&P 500 futures contracts.
What is the notional value of a futures contract? ›
In a futures contract, the notional value is the product of the number of units of the underlying asset and the specified contract price.
What is the notional amount of a contract? ›
The notional value is the total amount of a security's underlying asset at its spot price. The notional value distinguishes between the amount of money invested and the amount of money associated with the whole transaction. The notional value is calculated by multiplying the units in one contract by the spot price.
What is the notional amount in a forward contract? ›
The notional value of the contract is calculated by multiplying the contract unit by the futures price. Contract unit x contract price = notional value. 100 (troy ounces) x $1,000 = $100,000. If WTI Crude Oil is trading at $50 dollars and the contract unit is 1000 barrels, the notional would be; $50 x 1,000 = $50,000.
What is the notional value of an option contract? ›
– Options contracts: The notional value of an options contract is the value of the underlying asset that the option gives you the right to buy (in the case of a call option) or sell (in the case of a put option). This is simply the current market price of the underlying asset.
How do you value a futures contract? ›
The notional value of a futures contract demonstrates the value of the assets underlying the futures contract. To calculate the notional value of a futures contract, the contract size (in units) is multiplied by its current price. Notional value helps you understand and plan for the risks of trading futures contracts.
What is notional value in derivatives market? ›
Notional value is a term often used by derivatives traders to refer to the total value of the underlying asset in a contract. It can be the total value of a position, how much value a position controls, or an agreed-upon amount in a contract.
What is the purpose of notional amount? ›
The notional amount (or notional principal amount or notional value) on a financial instrument is the nominal or face amount that is used to calculate payments made on that instrument.
What is an example of a notional value? ›
1. Derivatives: In derivatives markets, such as futures and options, the notional value is the value of the underlying asset that the contract is based on. For example, in a futures contract for 100 barrels of oil, the notional value would be the current market price of 100 barrels of oil.
What is the difference between notional value and market value? ›
Notional vs market value – Basic differences
The notional value highlights the total value of assets which includes options, futures, stocks, foreign exchange, etc. In contrast, the market value is simply the security you pay for the total assets in the market.
Contract value, or "notional value." This is the contract size multiplied by the current price. For example, if /CL is trading for $65 per barrel, the notional value of one contract is $65,000 ($65 x 1,000). Tick size. Tick size is the minimum price increment a particular contract can fluctuate.
What is the minimum notional value? ›
As for the minimum notional value, it is used to calculate a minimum order value corresponding to the order quantity by using the minimum notional value or minimum order size. For example, BTCUSDT has a minimum notional value and minimum order size of 100 USDT and 0.001 BTC.
What is the difference between nominal and notional value? ›
Notional value refers to the nominal or face value of a financial instrument, on which payments are calculated. This value is referred to as notional, or nominal in some cases because it does not change. It is often used to value the underlying asset, in a derivatives contract.
What is the notional value of a futures market? ›
Derivatives: In derivatives markets, such as futures and options, the notional value is the value of the underlying asset that the contract is based on. For example, in a futures contract for 100 barrels of oil, the notional value would be the current market price of 100 barrels of oil.
What is the difference between notional value and contract value? ›
It is often used inderivatives trading, where the notional value refers to the underlying value of a contract or instrument without considering any market fluctuations or actual transactions. The notional value serves as a reference point for calculating payments or determining a position's size and risk exposure.
What determines the value of an option contract? ›
The factors determining the value of an option include the current stock price, the intrinsic value, the time to expiration or time value, volatility, interest rates, and cash dividends paid.
How do you calculate notional value of Treasury futures? ›
1. For derivatives contracts: – Futures contracts: The notional value of a futures contract is calculated by multiplying the contract size by the current market price of the underlying asset.
What is the intrinsic value of a futures contract? ›
Intrinsic Value (Puts)
It represents the difference between the current price of the underlying security and the option's exercise price, or strike price. Essentially, intrinsic value exists if the strike price is below the current market price in regard to calls and above for puts.
How much is one futures contract worth? ›
Also known as a contract's notional value, contract value is calculated by multiplying the size of the contract by the current price. For example, the E-mini S&P 500 contract is $50 times the price of the index. If the index is trading at 2,250, the value of one E-mini S&P 500 contract would be $112,500.
What is the fair value price of a futures contract? ›
In the futures market, fair value is the equilibrium price for a futures contract or the point where the supply of goods matches demand.
