F&O Trading: Why Different Derivative Contracts Have Different Lot Size | Motilal Oswal
F&O Trading: Why Different Derivative Contracts Have Different Lot Size | Motilal Oswal

Why Different Derivative Contracts Have Different Lot Size

One of the keys to understanding F&O trading is to understand the concept of lot sizes. The whole idea of lot sizes is about standardization. The key difference between futures and forwards is that futures are standardized while forwards are not. Since futures are standardized, they have a ready secondary market. What are the types of standardization available in futures market on equities?

Firstly, the F&O market has a common expiry on the last Thursday of any month and all the F&O contracts expire on that day. Secondly, futures and options are available in 1-month, 2 months and 3-months tenure. This is another important standardization which creates a ready secondary market. The third form of standardization is through lot sizes. SEBI defines lot sizes for all the indices and stocks that are permitted to trade in F&O. Let us understand the meaning of lot size in stock market and the logic for lot size of Nifty 50 stocks. Let also learn why do different stocks have different lot sizes? The table below captures an illustration.
 

UnderlyingLot SizeCMP (11-May-2018)Lot ValueNifty7510,807Rs.8.10 lakhBank Nifty4026,413Rs.10.57 lakhACC4001,466Rs.5.86 lakhAsian Paints6001285Rs.7.71 lakhBritannia Industries2005,479Rs.10.96 lakhBharti Airtel1700386Rs.6.56 lakhReliance Industries1000986Rs.9.86 lakhTata Steel1061606Rs.6.43 lakhTata Motors1500331Rs.4.97 lakhZee TV1300592Rs.7.69 lakh

Source: NSE
 

How are lot sizes fixed for Futures and Options?

Initially SEBI had fixed Rs.2 lakh as the indicative lot size. The lot size would be fixed at the relevant number of shares which if multiplied by the current market price would give a notional value of above Rs.2 lakh. However, in the year 2015 with a view to discouraging retail investors from speculating in F&O, SEBI modified the indicative lot sizes at above Rs.5 lakh. In fact, new additions to the F&O list are being included with a minimum lot value of Rs.7.50 lakh and there is a proposal to change the lot value to Rs.10 lakh so that only informed investors and traders actually trade in the F&O market. When the Nifty lot value was at Rs.2 lakh, the initial margin required for 1 lot of Nifty was just about Rs.25,000 and that made it accessible to most of the small traders. In most cases, they did not understand the actual implications of F&O and ended up with huge losses.
 

Why are lot sizes modified in the normal course?

While the lot sizes are pegged based on the indicative lot values, these lot values keep changing along with the price. For example, a stock with a lot size of 1000 shares with a price of Rs.210 will have a lot value of Rs.2.10 lakh. However, if the price of the stock goes up to Rs.550 over the next 1 year then the lot value automatically changes to Rs.5.50 lakhs. In such cases, SEBI may look to modify the lot size to 500 shares so that the lot value at Rs.2.75 lakhs is a more genuine reflection of the indicative lot value.

The reverse logic applies in case of stock price corrections. In these cases, SEBI revises the lot size upwards to make it more compatible with the indicative lot value. Such lot size revisions are done on a regular basis based on the stock price movements. The crux of the matter is that since indicative lot values are fixed the individual lot sizes have to be fixed based on the market price of the stock or the index. That is why lot sizes differ!
 

Why is SEBI worried about lower lot sizes?

Source: World Federation of Exchanges (WFE)

As the above chart captures clearly, the extent of speculation is very high in case of India and South Korea. SEBI is worried that lower lot sizes have opened the gates for retail investors with limited understanding of F&O to jump into futures and options. This has created losses and is adversely impacting the equity risk appetite among small investors. At a time when small investors need to leverage on equities to create wealth, the preponderance of F&O is making the landscape too risky.
 

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