Learn contract specs, lot size, expiry

WHY standardization? Because exchanges need liquidity — thousands of traders buying and selling the SAME contract. If everyone negotiated custom terms, you couldn't quickly match buyers with sellers.

Core Components of Contract Specifications

These specs are published by the exchange (NSE, BSE in India; CME, CBOE in US) and are non-negotiable for retail traders.

###1. Lot Size: The Building Block

$\text{Position Value} = \text{Number of Contracts} \times \text{Lot Size} \times \text{Current Price}$

Derivation from first principles:

• WHY does lot size exist? To standardize contract size for liquidity and margin calculation.
• HOW is it set? Exchanges aim for a contract value (notional) of ₹5-15 lakhs for Indian equity futures. If Reliance trades at ₹2,500/share, the lot size might be 250 shares to get ₹6.25 lakh notional.

Example: Nifty 50 Futures

• Underlying: Nifty 50 Index (e.g., 18,500)
• Lot Size: 50 units
• If you buy 1 contract: You control 50 × 18,500 = ₹9,25,000 worth of the index
• If you buy 2 contracts: 2 × 50 × 18,500 = ₹18,50,000 exposure

WHY this step? Multiplying contracts × lot size × price gives you the total market exposure — critical for calculating margin requirements and P&L.

Step-by-step:

1. Exposure per contract = 25 × 43,000 = ₹10,75,000
   • Why? The lot size (25) times the current index level.
2. Total exposure for 3 contracts = 3 × ₹10,75,000 = ₹32,25,000
   • Why? You're controlling 75 units (3 × 25) of the index.
3. Margin required ≈ 15% of ₹32,25,000 = ₹4,83,750 (SPAN + Exposure)
   • Why? You don't pay full₹32L upfront; you deposit margin as collateral.

If Bank Nifty rises to 43,500 (+500 points):

• P&L per contract = 25 × 500 = ₹12,500
• Total P&L = 3 × ₹12,500 = ₹37,500 profit
• Why? Each 1-point move in Bank Nifty = ₹25 profit/loss per contract (lot size 25).

2. Expiry Date: The Contract's Deadline

On expiry, the contract is cash-settled (for indices) or physically settled (for stocks).

WHY last Thursday? Historical convention for monthly expiry, allowing time before month-end accounting. If Thursday is a holiday, expiry moves to the previous trading day.

Contract Months:

• Near Month: Current month (e.g., July 2026)
• Next Month: Following month (August 2026)
• Far Month: Month after next (September 2026)

Most liquidity is in the near-month contract (>80% of volume).

$\text{Basis} = \text{Futures Price} - \text{Spot Price}$

As expiry approaches, basis → 0 (convergence). On expiry day:

$\text{Futures Price}_{\text{expiry}} = \text{Spot Price}_{\text{expiry}}$

Derivation:

• WHY? On expiry, a futures contract is equivalent to holding the underlying at spot price. No time premium remains.
• HOW? If futures > spot on expiry, arbitrageurs sell futures and buy spot, pocketing the difference. This trading forces convergence.

If you held1 long July Nifty futures from18,510 to expiry at 18,550:

• P&L = 50 points × 50 (lot size) = ₹100profit
• Why 50 points? 18,550 (settlement) - 18,510 (your entry).

3. Tick Size: The Minimum Price Movement

$\text{Tick Value} = \text{Tick Size} \times \text{Lot Size}$

Example: Nifty Futures

• Tick size =0.05 points
• Lot size = 50 Tick value = 0.05 × 50 = ₹2.50

So the minimum profit/loss per contract is ₹2.50 per tick.

WHY tick size? Prevents infinitesimal price differences that would clog the order book. It's like currency having paisa (0.01) as the smallest unit.

4. Rolling Over Contracts

WHY roll over? Because the current contract expires and ceases to exist. If you want to stay in the trade, you need a new contract.

HOW to roll over:

1. Sell (close) your July contract
2. Buy (open) the August contract
3. Pay/receive the rollover cost (difference in price between July and August)

Rollover steps:

1. Sell 2 July contracts at 18,500: Close position
2. Buy 2 August contracts at 18,520: Open new position
3. Rollover cost = (18,520 - 18,500) × 50 × 2 = 20 × 50 × 2 = ₹2,000 paid

Why the cost? August contract has more time to expiry, so it trades at a premium (carry cost). You pay this to extend your position.

Common Mistakes and Steel-Manning

Why it feels right: Intuition says you need the price of one unit.

The fix: You're trading a contract of50 units, not 1 unit. Exposure = 50 × 18,000 = ₹9,00,000. Margin ≈ 12-15% of this = ₹1,08,000 - ₹1,35,000.

Steel-man the mistake: The confusion arises because in stocks, you buy exact shares (10 shares = 10 × price). Futures force you into standardized lots, making the exposure larger and less intuitive.

Why it feels right: Stocks can be held indefinitely, so futures should be the same.

The fix: Futures contracts expire and are settled. For cash-settled index futures, your position is closed at the settlement price. For stock futures, you may face physical delivery (forced to buy/deliver the underlying stock), which requires full cash (not just margin).

Steel-man the mistake: The word "futures" sounds like "future indefinitely," not "a contract with a specific future date." The expiry mechanism is counter-intuitive if you're coming from equity investing.

Why it feels right: Once learned, specs feel permanent.

The fix: Exchanges revise lot sizes when underlying prices change significantly. Bank Nifty was 40units in 2018, reduced to 25 in 2022as the index rose. Always check current specs before trading.

Active Recall Practice

Also, this bet expires on finals day (the expiry date). On that day, if your team won, you get paid based on how much you bet. You can't keep the bet open forever — it ends on finals day, and the bookie pays you the difference.

Now, imagine the bookie updates the bet price every 5 rupees, not every single rupee (that's the tick size). So prices go1,000, 1,005, 1,010, not 1,000, 1,001, 1,002.

Futures contracts work the same way: you bet on a stock/index in fixed-size chunks (lot size), the bet expires on a fixed date, and prices move in small fixed steps. You need to know these rules before you place your bet!

Connections

• Introduction to Futures Contracts — what futures are conceptually
• Margin Requirements in Futures — how lot size affects margin
• Futures Pricing and Carry Cost — why far-month contracts trade at premium
• Physical vs Cash Settlement — what happens on expiry
• Rolling Over Futures Positions — managing expiry in long-term trades
• Options Contract Specifications — similar standardization for options
• Index Construction (Nifty 50) — what the underlying is index futures

Flashcards

#flashcards/stock-market

What is a futures contract lot size? :: The fixed number of units (shares, index points, barrels) in one contract, set by the exchange to standardize trading. Example: Nifty futures have a lot size of 50.

Concept Map

Hinglish (regional understanding)