# Leverage in Trading: Futures Contracts
Author: AlgoTest
Author URL: https://algotest.in/blog/author/algotest/
Published: 2024-08-28
Category: Product
Category URL: https://algotest.in/blog/category/product/
URL: https://algotest.in/blog/leverage-in-trading-futures-contracts/

Furthering our theme of ' [leverage in trading](https://algotest.in/blog/leverage-in-trading-2-25-crores-in-8-minutes/)’ from the last blog post.

This article will introduce the application of leverage in the FnO segment. We’ll start with futures.

Let's first define the concept of “ **_notional exposure_**”.

**_Notional exposure_** or **_notional value_** can be thought of as **_the total amount of the underlying instrument(s) that your position controls_**. What does this mean? Let's calculate the notional value of a futures trade as an example:

To buy one lot of Adani Enterprises futures, margin required = **_Rs 1,00,915_**

Calculate this here on [Margin Calculator](https://algotest.in/margin-calculator).

This gives you control of 250 shares of Adani Enterprises as the minimum lot size is 250 shares.

The notional value in this case is 250\*1770 = **Rs 4.4L**

So, **_Notional Exposure = Contract Size x Spot Price_**

**Now how is this notional value related to the amount of margin required?**

As you can see, when trading a futures contract, you have to **_pay a significantly lesser margin to achieve control of a certain number of shares_** as compared to buying the stock. This is **leverage**, and the ratio in this case is **_4:1 or 4 times_**.

So, **_leverage = notional exposure / margin required_**

Unlike the example from our previous article, you don’t need to borrow money to have a leveraged position. Hence, buying a futures contract **_by design_** gives you leverage!

## **Why is this important?**

As discussed in the previous article, leverage juices up your return if you’re correct, but can really hurt if you’re wrong.

Notional value is an important concept to grasp as a trader, because it helps you understand how leveraged you are. The **_more leveraged you are, the higher the risk_** if the position goes against you.

We'll spend a lot more time talking about notional value in the days to come, but first let's answer the burning question:

## **How do you use Notional Exposure to Determine your Risk?**

This is much easier to illustrate with an example.

Remember, **_Notional Exposure = Contract Size x Spot Price_**

In the Adani example above, the notional value is approximately **_Rs 4.4L_** for 1 lot of an Adani Enterprises futures contract. This means, that if the stock went to 0 for whatever reason, the most you'd lose is NOT just the Rs 1L you paid in margin, but you would **_ALSO OWE your broker Rs 3.4L_**.

To illustrate the magnitude of risk that is possessed by over-leveraging, let's take two types of trades on Adani Enterprises with a 6L account utilising roughly the same margin for both cases.

**_Trade A_**: Buy 320 shares of Adani Enterprises = Margin of Rs 5.6L

**_Trade B_**: Buy 2 Adani Enterprises futures contracts = Margin of Rs 5.6L

**Case 1: Adani Enterprises Rises by Rs 100 in 1 week**

What would our P&L look like in both trades if the stock rose by Rs 100 in both trades?

![](https://prod.superblogcdn.com/site_cuid_cmbhlz3q0002sxzc513a62pj5/images/66cf005b2bef40dd8ab3d90e1-1749227310714-compressed.png)P&L if Adani Enterprises rose by Rs 100 in a week for both our trades

Evidently, your **_ROI and hence annualised ROI is significantly higher_** when trading the futures contract instead of buying the stock.

**Case 2: Adani Enterprises Falls 70% in 1 week**

**Hindenburg Research** published a _(perhaps telling)_ report on the Adani group and their alleged "con” on the 24th of January, 2023. The aftermath resulted in Adani stocks hitting lower circuits, with Adani Enterprises falling 70% in the span of a week between **_25th Jan & 3rd Feb 2023_** _._

_PS: you can read the report here:_ [_https://hindenburgresearch.com/adani/_](https://hindenburgresearch.com/adani/)

In this scenario, what would our P&L numbers look like?

![](https://prod.superblogcdn.com/site_cuid_cmbhlz3q0002sxzc513a62pj5/images/66cf005b2bef40dd8ab3d9002-3-1749227310725-compressed.png)P&L if Adani Enterprises fell 70% from its LTP as it did between 25/01/23 & 03/02/23 for both our trades

Quite the blood-bath in both cases, but I think you can clearly see leverage at play on the downside, too.

In **Trade B**, not only would you **_lose the entire Rs 6L of capital in your trading account, you would now ALSO OWE your broker Rs 20,000!!_**

This, is why position sizing is key, and using notional exposure to position size is a great place to start. A **_1X_** notional exposure is a **decent starting point** for those new to trading.

However, you can trade with more than a 1X exposure even as a newbie, provided you sell ‘courses’ to offset your trading losses 😉😉

https://giphy.com/gifs/fazeclan-faze-clan-fazeup-hR0A1kHhm61XhJKahb

_POV: You start trading a furu's 'No Loss' strategy 🤠_

_NOTE:_ _Marked-to-market settlements in futures trading happens at the end of each day. In Trade B from above, the risk management mechanisms of the broker and the exchange would have resulted in margin calls in one's account. This would require you to furnish more capital in your trading account, or your positions would be squared off. For the sake of simplicity, however, we have disregarded this clearly illustrate the effect of leverage._


---
This blog is powered by Superblog. Visit https://superblog.ai to know more.
---