Notional value of a derivatives contract is the price of the underlying asset multiplied by the number of units of the underlying asset involved in the contract. Investors may use derivatives such as options or futures as a way to add leverage to their portfolio, to hedge against specific market conditions or to profit from falling prices.

Learn how notional value of derivatives work, and why investors should pay attention to it when trading derivatives.

## Definition and Example of the Notional Value of Derivatives

The notional value of a derivative describes the overall value of the assets involved in the derivatives contract based on the value of the underlying asset and the number of units involved in the contract.

For example, a typical futures contract for crude oil involves 1,000 barrels of oil. If one barrel currently costs $70, the notional value of that contract is:

**1,000 x $70 = $70,000**

The generic formula for calculating the notional value of a derivatives contract is:

**Units of the underlying asset in a contract x Value of one unit = Notional value**

Notional values are calculated differently for different types of futures contracts. It may be based on weight (gold futures), volume (oil futures), or a fixed multiplier (E-mini S&P 500 depends on the value of the S&P 500 index multiplied by a fixed multiplier of $50).

## How Does the Notional Value of Derivatives Work?

The notional value of a derivative expresses the overall value of the assets involved in the contract. This makes notional value a useful metric because it lets investors quickly understand the value of the assets in the contracts they are buying or selling.

Notional value commonly comes into play when investors are trying to hedge their portfolios.

For example, let’s take the E-mini S&P 500 futures contract. Each unit of this contract is equal to $50 multiplied by the value of the S&P 500 index. Suppose the S&P 500 index is at 4,000; the notional value of one E-mini S&P future contract would be $50 x 4,000 = $200,000.

Now imagine an investor who has $10 million invested in a diversified portfolio of U.S. stocks. They want to hedge their portfolio against a major downswing in stock prices. The investor might use E-mini S&P 500 futures contracts to hedge their investments.

If the notional value of one S&P 500 futures contract is $200,000, to fully hedge their portfolio, the investor needs to sell:

**$10 million / $200,000 = 50 contracts**

The price of the 50 contracts will be much less than $10 million, but the notional value is what lets the investor understand how much of the underlying asset those contracts will involve.

Many derivatives, such as options, can be highly risky to invest in because theoretically, they can lead to unlimited losses.

## Notional Value vs. Intrinsic Value

Notional value and intrinsic value are two measures of value that derivatives traders frequently use, but each term describes very different things.

Notional Value |
Intrinsic Value |
---|---|

Describes the value of the underlying assets | Describes the profit received by exercising a derivatives contract at that moment |

Is affected by changes in the underlying asset’s price | Is affected by changes in the underlying asset’s price |

Often used to measure trade volume of derivatives | Not useful for measuring trade volume |

Used to make hedging decisions |

Notional value focuses on the value of the underlying assets involved in a derivatives contract. Intrinsic value is related to the value of the underlying asset, but only in that it measures the profit an investor could realize by exercising the contract.

For example, an options contract typically involves 100 shares of a stock. If XYZ is trading at $10, one contract for XYZ has a notional value of $1,000 because it controls $1,000 worth of XYZ stock.

If an investor owns a put option on XYZ with a strike price of $11, the intrinsic value of that contract is $100 because they could exercise the contract to buy shares at a $100 discount to their market price.

While notional value lets investors know how many contracts they’d need to buy to hedge a position of a specific size, intrinsic value helps investors calculate the profit they could realize by exercising the contract. It, along with time value, is also one of the primary determinants of an option’s market value.

## What It Means for Individual Investors

Most individual investors likely aren’t investing in large enough amounts that they’ll feel the need to significantly hedge their portfolios. However, if you’re trading options or other derivatives, notional value may be useful because it can help you measure trade volume.

The more notional value traded in a specific derivatives market, the higher the trade volume of those contracts tends to be. If you want to trade highly-liquid derivatives, looking at notional value can help you find the options, futures, and other derivatives to trade.

### Key Takeaways

- Notional value measures the value of the assets controlled by a derivatives contract.
- Notional value equals contract unit multiplied by value of one unit.
- Calculations for notional value may differ for different types of contracts based on the underlying security.
- Notional value can be used to calculate trade volume or to determine how many contracts to purchase for hedging purposes.

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