To use any derivative you need two ideas: which direction you’re betting, and how big the bet really is. Both are easy to get wrong.
Long and short
- Long means you profit when the underlying rises. (Agreeing to buy at a fixed price is a long position — you win if the market price ends up higher.)
- Short means you profit when the underlying falls. (Agreeing to sell at a fixed price is short — you win if the price drops.)
A key feature of derivatives is how easily they let you go short. With shares, betting on a fall is awkward (you must borrow and sell). With a derivative, taking the short side is just as simple as the long — you pick your direction.
Notional: the size that matters
Here’s the part that surprises people. The notional is the full value of the underlying your contract controls — and it’s usually far larger than the cash you actually put up.
That oil contract for 100 barrels at $80 has a notional of $8,000 — even though you might only post a few hundred dollars to enter it. Your exposure (gains and losses) is on the full $8,000, not the small amount you deposited. A 10% move in oil swings your position by $800, which could be several times your deposit.
This gap between the small cash outlay and the large notional exposure is the seed of leverage — the subject of the next lesson, and the reason derivatives are so powerful and so dangerous.
The takeaway
Every derivative position has a direction — long (gain when the underlying rises) or short (gain when it falls) — and a notional size that’s typically far bigger than the cash you put down. Your gains and losses ride on the notional, not the deposit. (This is education, not investment advice.)