The derivatives play in India is set for an expansion with the NSE adding the Nifty Junior and CNX 100 futures contracts to its derivatives instruments list from June 1, 2007.
MUMBAI: The derivatives play in India is set for an expansion with the National Stock Exchange (NSE) adding the Nifty Junior and CNX 100 futures contracts to its derivatives instruments list from June 1, 2007. This would give investors a bigger choice of trading by broadening the basket of indices, which currently has the S&P CNX Nifty, Bank Nifty and CNX IT.
Nifty Junior and CNX 100 have large- and mid-cap stocks, which are being widely preferred at present. Till now, there were no index futures available on them, which posed a problem for those wanting to hedge their portfolios.
CNX-100 has the top 100 most-liquid stocks having a large market capitalisation. Nifty Junior comprises the last 50 stocks of the CNX-100 list, while the first 50 stocks are a part of the Nifty 50 index, which is already available for futures trading.
Now, instead of buying a stock futures contract for all the stocks that he holds in his portfolio, the investor can use the index futures to hedge his position depending on whether he has large-caps or mid- and small-caps in his portfolio, or both. So, if one has all large-cap stocks in his portfolio, he can use the Nifty 50 index futures to hedge. In case, there are mid-cap stocks in his portfolio then the Nifty Junior index futures is a better option. However, for a person who has both large-cap stocks as well as mid-cap stocks, the index future on CNX-100 provides the best combination for hedging.
Hedging is a phenomenon through which one can ensure that the losses from stock market investing are low, when the market declines. How can you do this? You can use either stock or index futures to hedge your portfolio.
An index futures contract is one in which the underlying is a stock market index. Let’s see how it works.
Under index futures, one puts a bet on what level the index would be at on some date in future. Until now, a futures’ investor could enter a contract stating that the Nifty 50 index would be at 4,500 levels in August 2007. Now, the same can be done with levels of CNX-100 and Nifty Junior. One can enter a futures contract for three months in advance. So, if you enter a contract in June, the expiry of the same can be June 30 (near month), July 31 (next month) or August 31 (far month).
Assume that an investor has exactly the same portfolio as the Nifty Junior, which is currently quoting at around 8,100. Let’s say the investor has 50 shares of each of the stocks in the index. Hence, the value of his total holding will be Rs 4.05 lakh (50 x 8100). To hedge this, the investor needs to sell futures. Let’s assume he decides to sell 50 contracts (minimum contract size on the Nifty Junior) of the far month index futures on the Nifty Junior at 8,300.
On the settlement date, the index and the index futures price equate. Let’s say this price is 8,400. Hence the profit made on selling the shares would be Rs 15,000 (8,400- 8,100) x 50)). At the same time, the investor would make a loss on buying back the index futures. The loss made on index futures would be Rs 5,000. ((8,300 - 8,400) x 50)). Hence the gain would be Rs 10,000.
This return would remain the same irrespective of the price of the index. Let’s say on the settlement date the index is at 8,000. The loss made on selling the shares would be Rs 5,000 (( 8000- 8100)x 50)). The gain made on buying back the futures would be Rs 15,000 (8,300 - 8,000) x 50)). Hence the overall gain would again be Rs 10,000.
The investor can also choose to unwind the contract before the expiry date. “For institutional investors who have positions in small-cap stocks, this will be a good hedging opportunity. Until now, investors who have taken positions in smallcaps, have had to use Nifty 50 as the hedge,” says Vivek Jain from the derivatives desk at Edelweiss Capital.
“But, with the introduction of Nifty Junior and CNX 100, they would get the benefit of a more appropriate hedge. This would take some time to pick up, though. Once the trade in contracts picks up, first it would benefit the institutional investors and the benefits would ultimately trickle down to the retail investors,” he added.
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