A notional value is a term used to describe the total value or amount associated with some sort of futures contract or other type of leveraged investment opportunity. This type of value is often determined when dealing with assets that are sold in currency markets, as well as commodities that are sold as part of a futures agreement or even with options on odd or even lots of stock. Determining the notional value focuses on identifying the number of units involved with the transaction, and multiplying that number by the price associated with those units.
One of the easiest ways to understand the notional value is to consider goods that are being used as the basis for a futures contract. Assuming the contract is structured to commit the buyer to purchase 1000 units and the spot price for those units is currently $500 US dollars each, this would mean that the notional value of the investment is currently set at $500,000 USD. Since the spot price represents the amount that the goods would bring if they were sold immediately, knowing the notional amount makes it easier for the investor to then project what will happen to the value of the investment by the date that the contract expires and it is necessary to complete the transaction. This means that if the units in question are likely to appreciate in the interim, the investor will want to lock in the current spot price as part of the contract, then sell the units at a profit later on.
Notional value is very helpful with making investment decisions involving a number of trades. Along with futures contracts, the same basic idea can apply to setting up options on stock issues. If the investor thinks that going with the current spot price as the basis for the transaction will result in being able to sell the assets later on at a profit, then the investment is a good deal. If the current notional value is such that there is little evidence that asset will appreciate over time or that it may even be worth less later on, then the investor can avoid making the purchase and look for a better investment.
It is important to note that assessing notional value is focused on identifying the value of the asset if it were sold immediately. Calculating the notional value in and of itself does not provide all the information that an investor needs to make a final decision on whether to buy, sell, or hold an asset. What the calculation does determine is the price that the investor would deal with in today’s market, and hopefully provide a basis for projecting what will happen to that price next week, next month, or a year from now. When the investor is able to use the notional value as a springboard for projecting that future activity, the chances of making a good investment and avoiding one with little to no promise are enhanced considerably.