In this article you learn about derivative Trading, Index derivatives .
History of Derivative trading at NSE
The derivatives trading on the NSE commenced on June 12, 2000 with futures trading on Nifty 50 Index. Subsequent trading in index options and options on individual securities commenced on June 4, 2001 and July 2, 2001. Single stock futures were launched on November 9, 2001. Ever since the product base has increased to include trading in futures and options on CNX IT Index, Bank Nifty Index, and Nifty Madcap 50 Indices etc. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in India. The derivatives contracts have a maximum of 3-month expiration cycles except for a long dated Nifty Options contract which has a maturity of 5 years. Three contracts are available for trading, with 1 month, 2 months and 3 months to expiry. A new contract is introduced on the next trading day following the expiry of the near month contract
Index derivatives are derivative contracts which have the index as the underlying. The most popular index derivative contracts the world over are index futures and index options. NSE’s market index, the Nifty 50 was scientifically designed to enable the launch of index-based products like index derivatives4 and index funds.
Following are the reasons of popularity of index derivatives:
- Institutional and large equity-holders need portfolio-hedging facility. Index- derivatives are more suited to them and more cost-effective than derivatives based on individual stocks. Pension funds in the US are known to use stock index futures for risk hedging purposes.
- Index derivatives offer ease of use for hedging any portfolio irrespective of its composition.
- Stock index is difficult to manipulate as compared to individual stock prices, more so In India, and the possibility of cornering is reduced. This is partly because an individual Stock has a limited supply, which can be cornered.
- Stock index, being an average, is much less volatile than individual stock prices. This Implies much lower capital adequacy and margin requirements.
Index derivatives are cash settled, and hence do not suffer from settlement delays and Problems related to bad delivery, forged/fake certificates.
- It is easier for retail investors to understand indices and track their movements, than Pick stocks and track them. Hence, index derivatives are more popular amongst retail Investors than stock indices.
The Nifty 50 is a float-adjusted market capitalization weighted index derived from economic research. It was designed not only as a barometer of market movement but also to be foundation of the new world of financial products based on the index like index futures, index options and index funds. A trillion calculations were expended to evolve the rules inside the Nifty 50 index.
The results of this work are remarkably simple: (a) the correct size to use is 50, (b) stocks considered for the Nifty 50 must be liquid by the ‘impact cost ‘criterion, (c) the largest 50 stocks that meet the criterion go into the index. The research that led up to Nifty 50 is well-respected internationally as a pioneering effort in better understanding how to make a stock market index. The Nifty 50 covers 21 sectors of the Indian economy and offers investment managers exposure to the Indian market in one efficient portfolio. It is used for a variety of purposes, such as bench-marking fund portfolios, index based derivatives and index funds. The Nifty is uniquely equipped as an index for the index derivatives market owing to its low Market impact cost and (b) high hedging effectiveness. The good diversification of Nifty generates low initial margin requirement.
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