Lot size is a term that is often used in financial markets. A lot size indicates the number of units of a security or other financial instrument bought/sold on an exchange. For example, in the stock markets, lot size means the total number of shares bought/sold in a single transaction. Lot size is generally used in derivatives trading.
Let’s have a look at this concept in further detail.
Lot size in futures and options trading
To understand F&O trading, one must understand lot sizes and how they work.
Read more: Your essential guide to futures and options trading
One of the major differences between futures and forwards contracts is that futures are standardized contracts whereas forwards are over-the-counter (OTC) derivatives. One of the factors apart from the expiry date, that standardizes futures contracts is the usage of lot sizes.
With the help of pre-defined lot sizes, futures contracts enjoy better liquidity in the secondary market. For example, if you wish to sell an odd number of stocks through a futures contract but find no buyers, you can use standard lot sizes to ensure that your contract gets a counterparty.
Similarly, in options trading, a lot size signifies the minimum quantity of the underlying asset that one can buy or sell.
The lot sizes for all major indices and stocks allowed in F&O trading are defined by SEBI. The list of lost sizes is frequently updated by the market regulator. The lot size of all F&O contracts for a specific underlying asset is generally the same.
How are lot sizes fixed in futures and options?
From the earlier days of F&O trading until 2015, SEBI had fixed Rs. 2 lakhs as the value of lot size for a security or index. This value, however, is the notional value and not the margin payable. A Futures contract will require one to pay a margin which is generally a fraction of the given notional value. Once a lot size or the number of securities is determined, it is multiplied by the current market price to arrive at the given notional value of Rs. 2 lakhs.
After 2015, SEBI started specifying the lot size for the determination of the notional value. Once the lot size is multiplied by the current market price, the net transaction value should be above Rs. 5 lakhs. There are chances that the market regulator will further increase the minimum limit to Rs 10 lakhs. Stocks that have newly been introduced in the options trading category will have a lot size of Rs 7.5 lakhs. Thus, lot size is not a fixed amount.
Why is fixing of lot size important?
Apart from helping in the standardisation of futures contracts, lot size is used as a tool by SEBI to better control the F&O market. In order to control the rise in speculation across the derivatives market, SEBI restricts smaller lot sizes. This ensures that small investors cannot easily enter the market without appropriate knowledge of derivatives. With smaller lot sizes, the risk appetite of small investors can get easily amended and result in higher volatility in the F&O segment. Since SEBI keeps on modifying the lot size, it acts as an entry barrier for retail participation and discourages speculation.
Conclusion
F&O lot sizes can keep changing from time to time depending on SEBI’s market watch and consequent decisions. The lot sizes are also impacted by individual stock or index prices. Therefore, it is important for every F&O participant to know about the ongoing lot sizes and enter trades accordingly.
FAQs
Yes, F&O markets are highly volatile and see participation from investors/traders who want to profit from speculation apart from hedging their risks.
F&O investing is ideally meant for traders/investors who want to hedge their risk in an underlying asset. Retailers can explore F&O segment only after gaining sufficient knowledge about this market.
In F&O trading, margin is the amount of money a trader has to deposit and maintain with the broker at the time of entering into a futures or options position. It represents a portion of the notional value of the contract.
In F&O trading, one can trade only using lot sizes that are defined by SEBI, depending on the underlying asset being traded.
