Why and how to trade in Nifty futures

An index future is a derivative, similar to a stock future, whose value is dependent on the value of the underlying, in this case, the index like the S&P CNX Nifty or BSE Sensex. 

By trading in index futures, an investor is buying and selling the basket of stocks comprising the index, in their respective weights. 

Stock index futures are traded in terms of number of contracts. Each contract would be to either buy or sell a fixed value of the index. The value of the contract would be the lot size multiplied by the index value.

About Nifty futures

Nifty futures are index futures where the underlying is the S&P CNX Nifty index. In India, index futures trading commenced in 2000 on the National Stock Exchange (NSE). 

For Nifty futures contracts, the permitted lot size is 50, and in multiples of 50. Like other futures contracts, Nifty futures contracts also have a three-month trading cycle -- the near-month, the next month and the far-month.

After the expiry of the near-month contract, a new contract of a three-month duration would be introduced on the next trading day. Investors can trade in Nifty futures by having a margin amount in their account. This margin is a percentage of the contract value. It is usually about 10-12 per cent.

Why should you go for them?

Hedging. In simple terms, hedging is a strategy that helps limit losses. Exposure to a stock is equivalent to exposure to an index. This is because most stocks move in tandem to the market. Exposure to index futures helps hedge this risk.

Speculative gains. If you are certain about future market movements, you can make profits through index futures. If you bullish on the market, buy index futures. If bearish, you should sell index futures.

How do they work? You enter into a Nifty futures contract at a specified index value. On the expiry of the contract, the investor's profits would be the difference between the level of the index on expiry and the level specified in the futures contract at the time of purchase.

Strategies

Short stock, long index futures. There are times when you sell the stock, but there is an upside in the market, thus resulting in lost potential profits. Index futures help you mitigate this risk. By buying index futures when you are short on the stock, you can minimise the amount of potential profits lost.

Equity portfolio, short index futures. There are times when you own a portfolio and are uncomfortable about market conditions. You can hedge this risk by selling index futures. The concept vests on the fact that every portfolio has index exposure and risks are accounted for by fluctuations in the index.

Long Stock, Short Index Futures

Suppose you are long 500 shares of Reliance Industries at the price of Rs 1,000 per share; spot Nifty is at 5,000; and Nifty futures is at 5,020.

To protect your Rs 5 lakh (Rs 500,000) position from a market downturn, you need to sell 100 Nifty futures. Suppose on the expiry date, the spot/futures Nifty is at 4,750 (5 per cent fall). On closing, both the positions, you would earn Rs 2,000. 

Your position in Reliance Industries would have dropped by Rs 25,000 and the short Nifty would have gained Rs 27,000 [i.e., 100 x (5,020-4,750)]

Short Stock, Long Index Futures

Suppose you are short 400 shares of Infosys Technologies at the price of Rs 2,500 per share; spot Nifty is at 5,000; and Nifty futures is at 5,050.

To protect your Rs 10 lakh (Rs 1 million) position from a market upside, you need to buy 200 Nifty futures. If, on expiry, the spot/futures Nifty is at 5,250 (5 per cent rise), on closing both positions, you lose nothing.

Your position in Infosys would result in a loss Rs 50,000 and the short Nifty would have gained Rs 50,000 [i.e., 200x(5,250-5000)]

Hedging Portfolio Risk

Suppose the spot Nifty is at 5,000 and the three-month Nifty futures at 5,015. To protect a portfolio of Rs 5 lakh (Rs 500,000) from a drop in the market, you need to sell 100 December Nifty futures.

Suppose on the expiry date, the spot/futures Nifty is at 4,500 (10 per cent fall). Your hedging strategy would earn you a profit of Rs 51,500[i.e., 100x(5,015-4500)], which compensates you for the Rs 50,000 (10 per cent) fall in your portfolio.

Source - http://business.rediff.com/slide-show/2010/jul/28/slide-show-1-perfin-why-and-how-to-trade-in-nifty-futures.htm

NSE launches volatility index-India VIX

National Stock Exchange on Monday announced the launch of India VIX, a volatility index being disseminated on a real-time basis for the first time.
India VIX is based on the index option prices of NSE's benchmark index NIFTY. 

India VIX is computed using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY option contracts, which are traded on the F&O segment of NSE, the Exchange said in a statement here.

The volatility index called the India VIX indicates the investor's perception of the market's volatility in the near term. The index depicts the expected market volatility over the next 30 calendar days i.e. higher the India VIX values, higher the expected volatility and vice-versa. 

So far, the volatility index, which is expressed in a percentage figure, was shown at the end of the day. But now it will be displayed on a real time basis, NSE release said. 

"Once India VIX is available for trading after regulatory approvals, it will give a lot of security to investors and traders, who face uncertainty, because the new product will empower them with better information and foresight. 

More importantly, it will give them the ability, to use the product to hedge their portfolios against the risk arising out of volatility," NSE's Managing Director & CEO, Ravi Narain said.

Source - http://business.rediff.com/report/2010/jul/19/nse-launches-volatility-index-india.htm

Stock market: What are circuit breakers?

Stock prices of companies listed on the stock exchanges are influenced by several factors - company financials, investor's perception of the company's growth, industry trends, government regulations, market speculation, to name a few.

Some factors are predictable and can be studied and analysed using statistical tools like graphs and techniques like ratio analysis, trend analysis, theory of probability etc.

Certain other factors and their influence on prices of a particular stock or the market in general and the degree of their impact are completely unpredictable.

Since market sentiments cannot be predicted accurately and their impact on stock prices is difficult to judge, sometimes the movement of stock prices can beat all logic and move tremendously in any direction.

Circuit Breaker is a system to sustain sanity of the stock market in such situations. For example, the BSE Sensex moved up by 2110.79 points on May 18, 2009 after the Parliament election results were announced. The trading had to be halted since the market became extremely volatile and moved beyond reasoning.

What is a circuit?

Circuits are of two types - circuit for an index and for a stock. So, if an index or the price of a stock increases or declines beyond a specified threshold it is said to have entered into a circuit. Securities and Exchange Board of India specifies this threshold as a percentage of the prior day's closing figures.

What is a circuit breaker?

Factors like market speculations force stock prices or indices to enter in a circuit. Such a condition is beyond the control of regulatory authorities. Hence they use the circuit breaker to curb such market situations. Circuit breaker, simply put, is a set of rules formed and issued by SEBI in order to bring back normalcy in the stock markets in the event an index or stock enters a circuit. SEBI has different circuit breakers for indices and for stocks.

Circuit breaker for an Index

Circuit breakers are applied only on equity and equity derivative markets. Whenever the major stock indices like BSE Sensex and Nifty cross the threshold level, SEBI rules require that the trading at the stock exchange be stopped for a certain period of time beginning from half an hour to even an entire day. The time frame for which trading is stopped depends upon the time and amount of movement in the indices. The idea is to allow the market to cool down and resume trading at normal levels. The thresholds are implemented stage wise.

Movement in Indices	Time	Close period
10 per cent	Before 1.00 pm	1 hour
	1.00 pm to 2.30 pm	½ hour
	After 2.30 pm	Does not close
15 per cent	Before 1.00 pm	2 hour
	1.00 pm to 2.30 pm	1 hour
	After 2.30 pm	Close for the rest of the day
20 per cent	Any time	Close for the rest of the day

Circuit Breaker for a stock

A price band specifies the span or price range for a stock to move without any interference from regulatory authorities. Only when the stock prices move beyond the range, it is considered as entering into a circuit and circuit breakers are applied. Daily price bands of 2 per cent, 5 per cent and 10 per cent are applicable to different equity stocks. Price bands of 20 per cent are applicable to all remaining scrip like preference shares or debentures. For example, for a stock with a price band of 5 per cent that closes at Rs100 on the previous day, the price band will be between Rs 105 and Rs 95.

What are an Upper circuit and Lower circuit?

Stock prices can either move up or down and hence circuit breakers are required for movements in both directions. An upward movement over the threshold will cause a stock to enter an upper circuit. Similarly a downward movement in stock price beyond the threshold will cause a stock to enter a lower circuit.

The objective of circuit breakers is to control the stock markets at times when they move beyond reasonable limits. When a stock enters an upper circuit, it puts an investor who has already invested in the stock at an advantage. On the contrary a stock movement into a lower circuit places the investor at a disadvantage because it is now difficult to sell off these shares as they have lost a lot of money.

Source - http://business.rediff.com/report/2010/jul/07/perfin-all-you-want-to-know-about-circuit-breakers.htm