One of my friend recently just wanted to get an idea about Nifty and How it is calculated. I am presenting some basic facts about Nifty here….
Background of Nifty
S&P CNX Nifty is a well diversified 50 stock index accounting for 21 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.
S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is India’s first specialised company focused upon the index as a core product. IISL has a Marketing and licensing agreement with Standard & Poor’s (S&P), who are world leaders in index services.
How Stocks are selected :
The constituents and the criteria for the selection judge the effectiveness of the index. Selection of the index set is based on the following criteria:
Liquidity (Impact Cost)
For inclusion in the index, the security should have traded at an average impact cost of 0.50% or less during the last six months for 90% of the observations for a basket size of Rs. 2 Crores.
Impact cost is cost of executing a transaction in a security in proportion to the weightage of its market capitalisation as against the index market capitalisation at any point of time. This is the percentage mark up suffered while buying / selling the desired quantity of a security compared to its ideal price (best buy + best sell) / 2
Companies eligible for inclusion in S&P CNX Nifty should have atleast 10% floating stock. For this purpose, floating stock shall mean stocks which are not held by the promoters and associated entities (where identifiable) of such companies.
a) A company which comes out with a IPO will be eligible for inclusion in the index, if it fulfills the normal eligiblity criteria for the index like impact cost, market capitalisation and floating stock, for a 3 month period instead of a 6 month period.
b) Replacement of Stock from the Index:
A stock may be replaced from an index for the following reasons:
i. Compulsory changes like corporate actions, delisting etc. In such a scenario, the stock having largest market capitalization and satisfying other requirements related to liquidity, turnover and free float will be considered for inclusion.
ii. When a better candidate is available in the replacement pool, which can replace the index stock i.e. the stock with the highest market capitalization in the replacement pool has at least twice the market capitalization of the index stock with the lowest market capitalization.
With respect to (2) above, a maximum of 10% of the index size (number of stocks in the index) may be changed in a calendar year. Changes carried out for (2) above are irrespective of changes, if any, carried out for (1) above.
And Finally how is the index calculation done
S&P CNX Nifty is computed using market capitalization weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value.
Source : NSE
Options, by definition, are a wasting asset. The time decay, declining volatility etc. eat away into the premiums of the options.
Many option buyers learn this fact the hard way by watching their option contracts expire worthless many times. The majority of options expire worthless (estimates are somewhere > 80%). Given that the majority of option buy positions are worthless at the time of expiration, some investors decide that they will sell options and collect the premium. Prima Facie, this sounds like an easy way to make money.
However, there is no free lunch in the investment field as well. There are stories of how some of the brightest people in the world have blown up their accounts while selling ‘Naked’ options. Selling options, when there are no underlying holdings to support in case of adverse move is known as ‘Naked’ Selling.
Nevertheless, Options selling, when used intelligently, can be used to complement/protect your portfolio holdings to a certain extent and also make income in return.
Investors earn a premium for every put and call option which they sell. This premium is paid by Option Buyers.
When you sell shares of a company which you do not own, then it is called short selling. Selling a stock short is taking a view that the shares will keep going down. One way of doing this is by selling Futures. And another way of doing this is by selling Call Options.
In a short sale you have to buy back the shares at some point. And thus, short selling exposes you to unlimited risk, if the price of the stock starts to increase.
There are numerous strategies in Options. I will present just one example of how the selling of call options can be used by investors :
Covered Call Strategy
A covered call strategy is strategy for bullish investors to make some money and benefit from a stock that will move little over the short term.
This is often employed when an investor has a short-term neutral view on a stock or when the Stock has made a decent up move in a relative short period of time, and is expected to be range bound in the near term.
Let us take the example of Larsen and Toubro (LNT) recent price action again.
Assume, Investors bought the stock @ 1400 or Traders bought it at the breakout above 1660 in early June. Next, the stock made a decent up move in a month’s time frame and touched almost 1900. Investors could have written an options contract selling one call option of LNT Jul 2010 strike price 1900 at Rs 40. (However, Remember that one call option gives an investor the right to buy 125 shares).
You would earn income because the buyer of the call option has to pay you a premium for the option. If the stock’s price drops stays below the strike price (In this case , LNT did close well below Rs 1900 by Jul end) , the call buyer will never exercise the contract and the entire premium is yours to keep (Remember one lot of LNT is 125 and that makes the premium monies Rs 125 * 40 = Rs 5000).
If the stock’s price increases above the strike price, the call buyer may choose to exercise the contract. You would then either have to buy shares on the open market or deliver your shares to the buyer.
This is one of the common ways in which large institutional players generate income on the basis of their large holdings which they can always use to hedge in case of any adverse move against their options position.
Again, the intention of this article is to arouse interest and make aware of Options Selling. It does not advocate that you start selling options. Please understand, when selling options, remember that although your profit potential is limited to the amount of the premium that you receive, your losses can be rather large.
Also, My personal view is that selling PUT Options carries higher risk than Selling CALL options. This is because , in general, stocks generally use the stairs when going up (Sellers of Call Options can manage risk here ….) , But Jump out of the window when coming down. (Sellers of Put options can run out of exit options or get trapped …)
LNT has indeed made a good move from 1660 to 1900 and which I have been tracking since Early June …
You might be interested to know about Buying Options here…