What Is Contract Size?
Contract size is the deliverable quantity of a stock, commodity, or other financial instrument that underlies a futures or options contract. It is a standardized amount that tells buyers and sellers exact quantities that are being bought or sold, based on the terms of the contract.
The size of the contract varies depending on the commodity or instrument. It also determines the dollar value of a unit move in the underlying commodity or instrument.
Understanding Contract Size
Commodities and financial instruments are traded in different ways. A transaction can be between banks themselves in a practice called over-the-counter (OTC) trading. In an OTC transaction, the buy or sell occurs between two institutions directly and not on a regulated exchange.
Commodities and financial instruments can also be traded on a regulated exchange. To help facilitate the trading, futures or options exchanges standardize contracts in terms of expiration dates, delivery methods, and contract sizes. Standardizing contracts reduces costs and improves trading efficiencies. Specifying contract size is an important part of this process.
For example, the contract size of a stock or equity option contract is standardized at 100 shares. This means that, if an investor exercises a call option to buy the stock, they entitled to buy 100 shares per option contract (at the strike price, through the expiration). An owner of a put option, on the other hand, can sell 100 shares per one contract held, if they decide to exercise their put option.
Contract sizes for commodities and other investments, such as currencies and interest rate futures, can vary widely. For example, the contract size for a Canadian dollar futures contract is C$100,000, 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. Each $1 move in the price of gold thus translates into a $100 change in the value of the gold futures contract.
The Pros and Cons of Contract Size
The fact that contracts are standardized to specify contract size is both good and bad. One advantage is that the traders are clear about their obligations. For instance, if a farmer sells three soybean contracts, it is understood that delivery involves 15,000 bushels (2 x 5,000 bushels), which will be paid in the exact dollar amount that is specified by the contact size.
A disadvantage of the standardized contract is that it is not amendable. The contract size cannot be modified. So if a food producer needs 7,000 bushels of soybeans, their choice is to either buy one contract for 5,000 (leaving 2,000 short) or buy two contracts for 10,000 bushels (leaving a surplus of 3,000). It is not possible to modify the contract size as in the over-the-counter market. In the OTC market, the amount of product being traded is much more flexible because the contracts, including size, are not standardized.