What Is a Contract Unit?
The term “contract unit” refers to the quantity of the underlying asset represented by a single derivatives contract. Depending on the nature of the contract, the underlying asset could be anything that is traded on the derivatives exchange, from agricultural commodities and metals to currencies and interest rates.
Since futures contracts are highly standardized, the contract unit will specify the exact amount and specifications of the asset, such as the number and quality of barrels of oil or the amount of foreign currency. In the case of equity options, for example, every contract corresponds to 100 shares.
- Contract units are an important part of a derivative contract, as they specify the quantity of the underlying asset associated with each contract.
- Different exchanges will have different conventions for their contract units, even relating to the same commodity.
- All contract units are standardized on each specific exchange.
- Knowing the quantity of an asset is important for speculators and hedgers as it provides them with the knowledge of how much of the underlying asset they are buying or selling.
- Contract units differ from trading units, as trading units specify the number of shares in a given block as deemed by an exchange.
How Contract Units Work
Derivative markets have become an increasingly important part of the global economy. Through them, industrial customers can efficiently source large quantities of commodities through a single centralized marketplace.
This has the advantage of decreasing transaction costs, increasing transaction fees, and reducing counterparty risk through clearinghouses and other systems. Financial buyers also actively participate in derivative markets, for purposes such as speculating on commodity prices or engaging in risk hedging activities.
One of the key components of every derivative contract is its contract unit. This critical clause captures the quantity and type of commodity being traded for each derivative contract.
Commodities are primarily offered via the exchanges of the CME Group, and contract units can be found on the exchange websites.
For example, if someone buys one corn futures contract, they are actually buying 5,000 bushels of corn, whereas if someone buys one oil contract, they are buying 1,000 barrels of oil. Gold futures, meanwhile, have a contract unit of 100 troy ounces.
If the unit is too large, many investors and traders who wish to hedge smaller exposures will be unable to use the exchange. Likewise, if the contract unit is too small, trading becomes expensive since there is a cost associated with each contract traded.
To help address this concern, some exchanges have introduced the concept of "mini" contracts to attract and retain smaller investors. By making it easier for these small investors to participate in the derivative markets, exchanges hope to increase the total liquidity of the market, thereby benefiting all investors.
Different futures contracts can have different contract units even if they are within the same asset category. For example, a CAD/USD futures contract traded on the Chicago Mercantile Exchange (CME) has a contract size of 100,000 CAD, while a Micro E-mini contract also traded on the CME has a size of 10,000 CAD.
Investors need to understand the conventions of the exchange they choose to trade on. Otherwise, they might accidentally expose themselves to a transaction whose value is far greater or lesser than what they had expected. It is imperative that anyone buying or selling futures contracts is aware of these differences and not assume that the unit of the currency will be the same across the board.
Contract Unit vs. Trading Unit
A trading unit, as defined by Nasdaq, is the number of shares of a security that is used as the acceptable quantity for trading on an exchange. Unlike a contract unit, a trading unit does not include a derivative as there is no underlying asset, it is specifically a number of shares that an exchange deems are needed for a security to trade on an exchange, usually in terms of blocks.
If a trader is taking delivery of one contract unit, they are not taking delivery of one piece of a commodity, but the amount of the commodity stipulated in that contract; for example, 5,000 bushels of corn in one contract.
A trading unit is typically a requirement set by an exchange to ensure that trading is facilitated efficiently and that there is enough liquidity. Trading units are often in the form of round lots or odd lots.
Round lots are usually 100 shares of stock while odd lots are a number less than 100. Understanding how a specific exchange defines a round lot or odd lot is crucial for an investor to know when making trading decisions.
What Is a Stock Trading Unit?
A stock trading unit refers to the number of shares that an exchange deems acceptable for trading as a block. Stock trading units are either odd lots or round lots. Round lots mean a block is equal to 100 shares while odd lots are a number below 100, usually determined by the specific exchange.
Is a Trading Unit the Same as a Share?
A trading unit is not the exact same term as a share. A share is the smallest denomination of the stock of a company. When purchasing stock of a company, you purchase a share or multiple shares. A trading unit refers to a specific number of shares in a purchase, most often referring to block trades. So a trading unit is made up of a specific number of shares.
What Is the Trading Unit for Corporate Bonds?
The trading unit for corporate bonds is usually $1,000 or $5,000. In some cases, it can be $10,000.
What Is a Round Lot?
A round lot refers to a specific number of shares traded as a block as determined by an exchange. One round lot is equal to 100 shares of stock. It can also be a larger number but usually needs to be divisible by 100.
What Is an Odd Lot?
An odd lot refers to a specific number of shares traded as a block as determined by an exchange that is less than a round lot, or 100 shares. Round lots (100 shares a block) are considered the standard, and anything less than that is considered an odd lot.
The Bottom Line
In the derivatives market, a contract unit refers to the quantity of the underlying asset in a derivatives contract. Knowing the contract unit of a derivative is essential as it relays to an investor how much of that asset they are buying or selling. This impacts the performance for speculators as well as price risk mitigation for hedgers.