What does it Mean By Notional Value?

Stock trading is a great way to build wealth and build a sufficient corpus. To become a successful stock trader, you need years of experience and practice. It is important to have a good understanding of stock trading strategies as well as the jargons involved in trading. One term that you'll often hear in stock trading is notional value. Let's now find out what notional value means.

What's a notional value?

The stock-trading term notional value is also known as notional amount. It is used to evaluate the underlying assets in a derivatives trade. It can be the total value for a particular position, the value that is controlled by a position, or an agreed-upon predetermined amount in a contract. The term notional value is commonly used to describe derivative contracts in currency markets and futures options.

Decoding notional

Let's now understand what a notional value is in the context of the stock exchange. The total amount of derivatives trading is the notional value. Leverage is a trading strategy that makes it possible to calculate the notional value or market value of derivatives contracts.

Leverage and notional value

Leverage in nominal value allows traders to control a larger sum with a smaller amount of money. Notional value helps to distinguish the total value of a trade from its market value. The price at which a position can be bought or sold on the market. Below is how you calculate the amount of leverage that you can use.

Leverage = Market Value

Stock trading contracts have a standardised and unique size that is determined by several factors, including weight, multipliers, and volume. A single Gold Futures Contract might weigh 3000g (weight), while an S & P index futures contract would be Rs. 3,500 multiplier. The notional value for the futures of gold is 100 times its market price, while the index future has a notional value at Rs. 3,500 times the market price of the S and P index. The notional value or amount is thus calculated as follows:

Noional value = Contract size x Underlying price

Notional value uses

Notional value can also be used to determine interest rate swaps, currency Swaps and equity options, in addition to futures and options contracts. In the case of interest rate swaps the notional value is determined based on interest rate payments to exchange. To the contrary, total return swaps involve parties paying either a fixed or floating rate of interest. This is multiplied with the notional amount plus the reduction in the notional value. The notional value in the case of equity options is the value that can be controlled by options.

Last note:

You now have an understanding of what notional amounts mean. Now you can do some research on it.