Notional Value Definition - Investopedia

In market parlance, notional value is the total underlying amount of a derivatives trade. The notional value of derivative contracts is much higher than the ... TradingSkills TradingBasicEducation WhatIsNotionalValue? Notionalvalueisatermoftenusedtovaluetheunderlyingassetinaderivativestrade.Itcanbethetotalvalueofa position,howmuchvalueapositioncontrols,oranagreed-uponamountinacontract.Thistermisusedwhendescribingderivativecontractsintheoptions,futures,andcurrencymarkets. 1:33 NotionalValue UnderstandingNotionalValue Inmarketparlance,notionalvalueisthetotalunderlyingamountofaderivativestrade.Thenotionalvalueofderivativecontractsismuchhigherthanthemarketvalueduetoaconceptcalledleverage. Leverageallowsonetouseasmallamountofmoneytotheoreticallycontrolamuchlargeramount.So,notionalvaluehelpsdistinguishthetotalvalueofatradefromthecost(ormarketvalue)oftakingthetrade,Thereisacleardistinction:thenotionalvalueaccountsforthetotalvalueoftheposition,whilethemarketvalueisthepriceatwhichthatpositioncanbeboughtorsoldinthemarketplace.Theamountofleverageutilizedcanbecalculatedbydividingnotionalvaluebymarketvalue. Leverage=Notionalvalue÷marketvalue Acontracthasaunique,standardizedsizethatcanbebasedonfactorssuchasweight,volume,ormultiplier.Forexample,asingleCOMEXGoldfuturescontractunit(GC)is100troyounces,andanE-miniS&P500indexfuturescontracthasa$50multiplier.Thenotionalvalueoftheformeris100timesthemarketpriceofgoldwhilethenotionalvalueofthelatteris$50timesthemarketpriceoftheS&P500index. Notionalvalue=Contractsize*underlyingprice IfsomeonebuysanE-miniS&P500contractat2,800,thenthatsinglefuturescontractisworth$140,000($50x2,800).Therefore,$140,000isthenotionalvalueofthatunderlyingfuturescontract.Thepersonbuyingthiscontractisnotrequiredtoputup$140,000whentakingthetrade,though. Rather,theyonlyneedtoputupanamountcalledtheinitialmargin,(marketvalue)whichisusuallyafractionofthenotionalamount.Theleverageusedwouldbethenotionalamountdividedbythepriceofbuyingthecontract.Iftheprice(initialmargin)foronecontractwas$10,000,thenthetraderwasabletoutilize(140,000/10,000)14timesleverage. Notionalvalueisintegralinassessingportfolioriskwhichcanbeveryusefulwhendetermininghedgeratiostooffsetthatrisk.Forexample,afundhasa$1,000,000longexposuretoUSequitymarketandthefundmanagerwantstooffsetthatriskusingtheE-miniS&P500futurescontracts.TheywouldhavetosellanapproximatelyequivalentamountofS&P500futurescontractstohedgetheirmarketexposurerisk.Usingtheaboveexample,thenotionalvalueofeachE-miniS&P500futurescontractis$140,000andthemarketvalueis$10,000. Hedgeratio=Cashexposurerisk÷notionalvalueofrelatedunderlyingasset Hedgeratio=$1,000,000÷$140,000=7.14 So,thefundmanagerwouldsellapproximately7E-miniS&P500contractstoeffectivelyhedgetheirlongcashpositionagainstmarketrisk.Themarketvalue(cost)wouldbe$70,000. Whilenotionalvaluecanbeusedinfuturesandstocks(totalvalueofthestockposition)inthewaysdiscussedabove,notionalvaluealsoappliesto interestrateswaps,totalreturnswaps,equityoptions,andforeigncurrency derivatives. KeyTakeaways Notionalvalueisatermoftenusedtovaluetheunderlyingassetinaderivativestrade.Notionalvalueofderivativescontractsismuchhigherthanthemarketvalueduetoaconceptcalledleverage.Notionalvalueisintegralinassessingportfoliorisk,whichcanbeveryusefulwhendetermininghedgeratiostooffsetthatrisk. InterestRateSwaps Ininterestrateswaps,thenotionalvalueisthespecifiedvalueuponwhichinterestratepaymentswillbeexchanged.Thenotionalvalueininterestrateswapsisusedtocomeupwiththeamountofinterestdue.Typically,thenotionalvalueonthesetypesofcontractsisfixedduringthelifeofthecontract. TotalReturnSwaps Totalreturnswapsinvolveapartythatpaysafloatingorfixedratemultipliedbyanotionalvalueamountplusthedecreaseinnotionalvalue.Thisisswappedforpaymentsbyanotherpartythatpaystheappreciationofnotionalvalue. EquityOptions Notionalvalueinanoptionreferstothevaluethattheoptioncontrols. Forexample,ABCistradingfor$20withaparticularABCcalloptioncosting$1.50.Oneequityoptioncontrols100underlyingshares.Atraderpurchasestheoptionfor$1.50x100=$150. Thenotionalvalueoftheoptionis$20x100=$2,000.Buyingthestockoptioncontractwouldpotentiallygivethetradercontroloverahundredsharesofstockfor$150comparedtoiftheypurchasedthestocksoutrightfor$2,000. Thenotionalvalueofanequityoptionscontractisthevalueofthesharesthatarecontrolledratherthanthecostofthetransaction. ForeignCurrencyExchangeandForeignCurrencyDerivatives Foreignexchangederivativeslikeforwardsandoptionshavetwonotionalvalues.Sincethesetransactionsinvolve twocurrencies,theybothreceiveseparatenotionalvalues.Forexample,ifatthetimeof atrade,theexchangeratebetweentheBritishpound(GBP)andtheUSdollar(USD)is1.5,then$1,000,000USDisequivalentto666,667GBP. ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. CMEGroup."S&P500FuturesandOptionsonFutures,"Page1.AccessedSept.28,2020. CMEGroup."WelcometoCOMEXGoldFutures."AccessedSept.28,2020. CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. Provider Name Description RelatedTerms WhatIstheS&P500Mini? TheE-miniS&P500isanelectronically-tradedfuturescontractrepresentingone-fifthofthevalueofthestandardS&P500futurescontract. more ContractUnit Contractunitisthequantityofanunderlyingassetrepresentedbyasinglederivativescontract.Learnhowatradingunitdiffersfromacontractunit. more Underlying Underlying,usedinbothequitiesandderivatives,isthesecuritythatmustbedeliveredwhenacontractorwarrantisexercised.Itcanbeastock,bond,oranotherfinancialinstrument. more WhatisanE-Mini? AnE-miniS&P500isanelectronicallytradedfuturescontractthatisafractionofthevalueofastandardfuturescontract.ReadaboutE-miniinvestinghere. more WhatAreMini-SizedDowOptions? Amini-sizedDowisatypeofoptionforwhichtheunderlyingassetsaretheE-MiniDowfutures.E-mini-Dowfuturesareworth$5multipliedbytheDJIA. more WhatIsPhysicalDelivery? Physicaldeliveryisaterminanoptionsorfuturescontractwhichrequirestheactualunderlyingassettobedeliveredonaspecifieddeliverydate. more PartnerLinks RelatedArticles TechnicalAnalysisBasicEducation NotionalValuevs.MarketValue:What'stheDifference? FinancialFuturesTrading HowDoS&P500FuturesWork? Options&DerivativesTrading HowBigIstheDerivativesMarket? Futures&CommoditiesTrading HowtoTradeFutures Buying&Selling CryptocurrencyExchangeRatingMethodology TradingInstruments 5PopularDerivativesandHowTheyWork