Comments
The NSE recently reduced the permitted lot size on 35 securities in the F&O segment. The revised contract size will apply from October 27 for the November and later contracts for 32 of these securities. This week, we discuss the effect of this revision on trading.
Contract multiplier
Take REC. The contract size will reduce from 8,000 to 2,000. The revision in the permitted lot size is related to the recent increase in the stock price. Note that the notional value concept is applied to determine the permitted lot size for a security that enters the futures and options segment for the first time. If a stock closes the previous day in the spot market (cash market) at 500 and the security is scheduled to list in the F&O segment today, the permitted lot size will be 1,000 based on the current notional value of ₹5 lakh.
The permitted lot size indicates how many shares you are obligated to buy if you keep your long position open till expiry. Conversely, it means how many shares you are obligated to deliver if you have a short position open till expiry. But most traders do not keep their positions open till expiry. The objective of trading futures or options is to bet on the prices moving up or down based on your view on the underlying asset. So, you would want to close your long position or short position and take profits rather than use the derivatives to take or give delivery of the underlying shares.
From this perspective, the permitted lot size acts as a contract multiplier. For instance, if futures price of REC increases 10 points, you can gain 80,000 based on the current lot size of 8,000. But this could reduce to 20,000 from October 27 when the revised lot size applies. This seems to suggest that a reduced lot size will lower your potential gains in futures trading. But that need not be true. When the permitted lot size is reduced, your initial margin will also reduce. That means you can increase your position size if you prefer to trade with the same capital that you employ on the current lot size. Suppose the current margin requirement based on a permitted lot size of 2,000 is ₹2.53 lakh. Then, the new margin requirement could be halved if the revised contract size is 1,000. That could allow you to double your position size if you trade with your original capital amount.
Optional reading
The reduction in permitted lot size will also allow you to trade certain securities that may not have been part of your trading universe earlier because of higher margin requirements. Note that the above arguments apply for options trading too. The cost per contract will be lower for long option positions and your margins will be lower for short option positions. You may have to increase your position size to increase potential gains.
The author offers training programmes for individuals to manage their personal investments
Comments
COMMENT NOW
Comments
Comments have to be in English, and in full sentences. They cannot be abusive or personal. Please abide by our community guidelines for posting your comments.
We have migrated to a new commenting platform. If you are already a registered user of TheHindu Businessline and logged in, you may continue to engage with our articles. If you do not have an account please register and login to post comments. Users can access their older comments by logging into their accounts on Vuukle.