Notional value of a derivative: how much underlying exposure sits behind the margin

The notional value of a derivative is the value of the underlying asset covered by the contract: the price of the underlying multiplied by the quantity in one lot. It is not the money you pay to open the position, nor the amount you can lose in a day. It is the scale of your exposure: profit and loss are calculated on the notional, while the initial margin is charged on only a fraction of it. Hence the key practical takeaway for a trader: size a position by its notional, not by its margin.

How notional is calculated

For a futures contract the formula is simple: the notional equals the current futures price multiplied by the lot size set out in the contract specification. If a single-stock futures lot represents a given number of shares, the notional of the position is the value of that block of shares at the contract price. For a currency future it is the amount of currency in the lot converted at the exchange rate. For an index future it is the index level multiplied by the point value defined in the specification.

Each contract has its own lot size and tick size, and these should only ever be taken from the exchange's specification. They also determine how many roubles each minimum price move adds to or takes from your account. This is covered in more detail in the glossary entry on tick value: notional and tick value describe the same thing from two angles — the full exposure and its smallest increment.

For an option, the notional is determined the same way, by the underlying asset rather than by the premium. The option buyer pays a premium, but the contract refers to the full amount of the underlying. That is why the premium is small while the notional can be large. To gauge the real risk of an options position, the notional is usually adjusted for delta: this gives an equivalent position in the underlying, which changes as the price moves.

For an interest rate swap, the notional is a reference amount on which the interest payments are calculated. It never changes hands between the counterparties; only the net interest difference is exchanged. So a swap's notional answers the question "what are the payments calculated on", not "what is the position worth".

Notional versus initial margin

In the derivatives market, the broker and the exchange block initial margin — collateral equal to a fraction of the notional. That fraction is what creates the built-in leverage. A trader sees the margin amount in the trading terminal and may conclude that this is what they are risking. That is a mistake: if the price of the underlying moves by a meaningful percentage, variation margin is debited from the account on the basis of the notional, and the loss can exceed the original margin.

The right sequence of thinking is:

• first, decide what notional you are prepared to hold relative to the size of your account;
• then look at the tick value and where your stop-loss sits;
• and only then check whether you have enough free funds to cover the margin.

If you start from the margin, the position is sized to the collateral available rather than to the risk you can tolerate. That is exactly how traders build up, in a calm market, a position they cannot survive in a volatile one.

Why aggregate notional is misleading

Bank reports and market statistics often cite the aggregate notional of outstanding derivatives. These figures look enormous, but they say little about economic risk. First, long and short positions in the same asset are added together into gross notional even though they offset each other. Second, a swap's notional never changes hands. Third, out-of-the-money options carry a large notional but a low probability of exercise.

To assess actual exposure, analysts use net notional for each underlying asset, delta-equivalent exposure for options and the current market value of the contracts. The same rule applies to a personal portfolio: adding up the notional of a futures position and of a hedging position in shares makes no sense — what matters is the net direction.

Notional and the cost of carry

The futures price differs from the price of the underlying by the cost of carry — the financing cost minus any income the asset generates over the life of the contract (dividends, for example). As a result, the notional of a single-stock future and the value of the same block of shares on the spot market do not match exactly. The difference is explained in the glossary entry on the cost of carry. For single-stock futures it is shifted noticeably by dividend payments, so their dates are worth checking against the dividend calendar:

Common trader mistakes

The first mistake is measuring leverage by the number of contracts rather than by notional. Contracts on different assets have different lot sizes, so the same number of lots can mean entirely different exposure.

The second is confusing an option's notional with the buyer's risk. The buyer risks the premium; the seller risks an amount tied to the notional. Writing uncovered options looks profitable precisely because the notional is not visible.

The third is forgetting about transaction costs. Commissions in the derivatives market are often charged per contract rather than as a percentage of notional, so their share depends on the lot size. How to work out the full cost of trading is explained in our article on brokerage fees.

The fourth is failing to distinguish notional from fair valuation. Notional is a technical figure taken from the specification; the market price of the contract and the fair value of the underlying asset are different concepts.

What to check before a trade

Before opening a position, it helps to answer a few questions: what is the notional of the position in roubles, what share of the account does it represent, what is the tick value, what move in the underlying would wipe out the entire margin, and is there an event in the coming weeks that could make the price gap. Issuers' financial reports and corporate events can be tracked in the events calendar.

This article does not quote specific lot sizes, tick sizes or margin rates: they are set by exchange specifications and by brokers, and they change. Check them against the primary source before every trade.