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Contract Size - Definition
Contract Size in futures trading is the amount of underlying asset represented by each futures contract.
Contract Size - Introduction
Contract size, also known as "Contract Multiplier", is one of the most important basic concepts to understand in futures trading. Contract size not only affects the actual amount of the underlying asset you are controlling, it also affects how volatile the price of your futures position is when taken into consideration with the minimum tick of the futures contract. In fact, not being sensitive to the contract size of the futures contracts you are trading can result in surprising and unexpected losses as well as margin calls.
This tutorial shall explore what Contract Size is in futures trading, how to calculate your contract size and how it affects the way you trade futures.
What is Contract Size in Futures Trading?
Contract size tells you how much of the underlying asset is covered by each futures contract and is an extremely important piece of information in futures trading because you need it to work out the "Total Contract Value" which is the first step to calculating the "Initial Margin" requirement. Contract size is also extremely important for risk management and calculating your stop loss point and we will discuss that below.
For instance, the contract size of wheat futures is 5000 bushels. This means that a single wheat futures contract covers the trading of 5000 bushels of wheat. This means that by trading a single wheat futures contract, you are trading the price movement of 5000 bushels of wheat at once. By final settlement, 5000 bushels of wheat will exchange hands between the two parties involved in that 1 contract of wheat futures. This is the same for Single Stock Futures where one futures contract typically covers the trading of 100 shares of the underlying stock.
For Index Futures, contract size is simply the cash value per point of the index covered. For instance, the contract size for Nikkei225 Futures traded on CME is 500 yen per point. This means that if the Nikkei225 index is trading at 1000 points, 1 contract of Nikkei225 Futures will have a contract value of 500 x 1000 = 500,000 yen. Since there is no physical asset behind an index future, the term "Contract Multiplier" is more commonly used than "Contract Size".
You can get the contract size of the futures contract you wish to trade from the specifications released by the exchange or broker.
Learn about the different Kinds of Futures Contracts.
How Does Contract Size Affect Your Futures Trading?
Contract size affects two main areas in futures trading; Capital Outlay and Price Movement Per Tick. The bigger the contract size, the bigger the capital outlay per contract due to a bigger total contract value. A bigger contract size also results in a bigger price movement per tick, making a futures position more volatile.
How Contract Size Affect Capital Outlay
Capital outlay in futures trading comes in the form of "Initial Margin". Initial margin is a fraction of the total contract value that is paid as goodwill deposit when entering into a futures transaction. As such, the bigger the total contract value, the more initial margin is payable for a futures position since contract value is directly affected by contract size. As such, the bigger the contract size, the higher the contract value will be and therefore, the higher the capital outlay per contract.
How Contract Size Affect Price Movement Per Tick
Futures prices move in what are known as "Ticks". You will always see a parameter known as "Minimum Tick" in every futures specification. This specifies the amount of money moved in a single "tick". For instance, if a futures contract has a minimum tick of $0.10, it's price will move by units of $0.10. Contract size and minimum tick work together to tell us how much the price of a futures contract will move in actual dollars per tick. Therefore, the higher the contract size, the higher the price movement per tick given the same minimum tick, resulting in higher price volatility.
As we can see from the example above, the price movement per tick for the S&P500 index futures is higher than the E-mini even though its minimum tick is lower due to its much higher contract size. Even though the S&P500 Index Futures has a higher price movement per tick, it is actually less volatile relative to its capital outlay than its E-mini contracts.
In the commodity futures market, traders who wants a smaller contract size frequently trades in futures contracts of a related commodity with a smaller contract size rather than futures contracts of the actual commodity in mind.
Total Contract Size and Total Contract Value
For futures traders trading futures positions many contracts at a time, knowing the contract size is the first step to calculating the total contract size and total contract value of the futures position. This tells you your extent of exposure and is the first step to risk management in futures trading.
By going long on 5 contracts of the above wheat futures, you are exposed to the trading of 25,000 bushels of wheat with a total value of $1,823,000.