What is Contract Size
Contract size is the deliverable quantity of commodities or financial instruments underlying futures and options contracts that are traded on an exchange. These contracts trade with margin requirements and daily settlement. The contract size is standardized for such futures and options contracts so that buyers and sellers know the exact quantity and specification of what they are buying and selling. Contract size varies depending on the commodity or instrument that is traded. The contract size also determines the dollar value of a unit move in the underlying commodity or instrument.
BREAKING DOWN Contract Size
There are many different ways to trade commodities and financial instruments. The most popular way is between banks themselves in a practice called over-the-counter (OTC) trading, wherein the transaction occurs between the institutions directly and not on a regulated exchange. These same commodities and financial instruments can also be traded on a regulated exchange. Exchange houses use contracts as a way to standardize the instruments being traded. This reduces costs and improves trading efficiencies. Part of the standardization process includes specifying a contract size.
For example, the contract size of most equity option contracts is 100 shares. However, the contract size for commodities and financial instruments such as currencies and interest rate futures varies widely. For example, the contract size for a Canadian dollar futures contract is C$100,000, while the size of a soybean contract traded on the Chicago Board of Trade is 5,000 bushels, and the size of a gold futures contract on the COMEX is 100 ounces. Therefore, each $1 move in the price of gold translates into a $100 change in the value of the gold futures contract.
Specifying the contract size has both advantages and disadvantages for traders. One key advantage is that the users are clear about their obligations. If a farmer sells three soybean contracts, for example, then she understands that she needs to supply 15,000 bushels and will be paid the exact dollar amount that is specified by the contact size. One key disadvantage of the contract size is that it is not amendable. These contracts are standardized. So if a food producer needs 7,000 bushels of soybeans, he will either have to buy one contract for 5,000 (leaving him 2,000 short) or buy two contracts for 10,000 bushels (leaving him a surplus of 3,000). It is not possible to modify the contract size in the same way as in the over-the-counter market. In the OTC market, the amount of product being traded is much more flexible, which can come at a higher cost for the same product.