What Is Contract Size?
Contract size refers to the deliverable quantity of a stock, commodity, or other financial instruments that underlie 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. Contract sizes are often standardized by exchanges.
The size of the contract varies depending on the commodity or instrument. It also determines the dollar value of a unit move (tick size) in the underlying commodity or instrument.
- The contract size refers to the amount or quantity of an underlying security that a derivatives contract represents.
- Contract sizes help standardize trading on markets, making them more orderly, transparent, and efficient.
- Contract sizes vary by asset type and exchange; for instance, U.S. listed equity options have a contract size of 100 shares per contract.
Understanding Contract Size
Derivatives contracts are securities that are based on the price of some underlying asset, such as stocks, bonds, commodities, currencies, and so on. The amount of the underlying asset represented in a derivative contract is its contract size.
Derivatives and other financial instruments are traded in different ways. A transaction can occur directly 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.
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.
Pros and Cons of Standardized Contract Sizes
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 (3 x 5,000 bushels), which will be paid in the exact dollar amount that is specified by the contract 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 OTC market. In the OTC market, the amount of product being traded is much more flexible because the contracts, including size, are not standardized.
Examples of Contract Size
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.
In listed options markets, the standard contract size for an equity option is 100 shares of stock. This means that if an investor exercises a call option to buy the stock, they are 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. Thus, 10 contracts similarly represent control of 1,000 shares.
E-minis are a class of electronically traded futures contracts that have a contract size that is a fraction of the corresponding standard futures contract. E-minis are predominantly traded on the Chicago Mercantile Exchange (CME) and are available on a wide range of indexes, such as the Nasdaq 100, S&P 500, S&P MidCap 400, and Russell 2000, commodities, such as gold, and currencies, such as the euro.
The E-mini S&P 500, for example, is an electronically traded futures contract on the CME that has a contract size one-fifth that of the standard S&P 500 futures contract. There really is nothing a full-sized contract can do that an E-mini cannot do. Both are valuable tools that investors use for speculating and hedging. The only difference being that smaller players can participate with smaller commitments of money using E-minis.