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…
The central bank raised interest on Tuesday in the face of inflation has been above 10 percent for the past five months. The Reserve Bank of India said it would continue to normalize policy in line with the growth and inflation rate in the economy.
The RBI lifted the repo rate, at which it lends to banks, by 25 basis points to 5.75 percent, which was in line with expectations, but raised the reverse repo rate, at which it absorbs excess cash from the system, by a steeper than expected 50 basis points to 4.50 percent.
The central bank left the cash reserve ratio (CRR) unchanged at 6 percent.
Inflation in India emerged last year in the wake of a poor monsoon that drove up food prices but has spread broadly throughout the economy, spawning protests against a government whose voter base is predominantly poor and rural. New Delhi’s decision to increase fuel prices is expected to add nearly a percentage point to wholesale price index (WPI) inflation starting in July and led the opposition to call a one-day nationwide strike early this month.
The government is hoping on normal summer monsoon rains to results in better crop yields and ease pressure on food prices, and has said inflation should decline to 6 percent by December, which in my opinion is a task in itself…..
“No amount of talking or reading can teach you swimming. You will have to get in the water.”
There are these little general rules which are applicable and useful for decision making and taking actions. And these simple rules are applicable in so many aspects of life, they are just some small reminders, some common-sense stuff which are really useful.
And yes most of them are applicable in investment planning as well.
a. Perfect Plan – Forget it.There is no such thing as a perfect investment plan and no such thing as a perfect time. The right time is now. Tomorrow is and always will be uncertain. Perfectionism is the enemy of action. Do not let perfect investment plan or a perfect time to invest stop you from starting.
b. Analysis Paralysis – Too much thinking will often result in getting stuck.Some thinking is good — it’s good to have a clear picture of where you’re going or why you’re doing this — but don’t get stuck thinking. Just do.
c. Get the Broad Picture and Start. You need to get the broad picture in your mind. You need to understand your future requirements or what do you want to achieve (goals). You need to know the time you have to meet those requirements. And, then you should have the broad plan to meet the goals. Once you have the broad picture. Get going.
All the planning will take you nowhere unless you take that first step, no matter how small it is.
d. Keep things Simple and take Small Steps. Small steps always work. Little tiny blows can break down that mountain. And then each step counts. Keep the big picture in mind, but start by taking small steps.
Understand the advantage of Investing Early here.
The Little Rules to successful action To be contd … Part 2.
In the process of investing, one often makes mistakes.
Here are some of the most common investing mistakes which investors generally make and some of which even I had made in the earlier part of my investment years
Of course, learning from the mistakes, continually, the investing experience has truly been rewarding experience.
You can also cultivate good habits of investing by avoiding the following mistakes.
This post ( Part III ) will throw light on the following common mistakes generally committed by investors:
#6. Having Unrealistic Expectations from Investments & Wrong understanding of Risk
Indexes (Sensex and Nifty) have gained more than 85% returns from the lows of March 2009. All the TV channels and newspaper headlines have started to focus on this aspect a lot andfuel greedin common people. Similarly just 2 months earlier to March 2009, or so, when there seemed no end to the global markets falling down, were down more than -ve 50% , the same TV channels and newspapers were fueling fearsinto the minds of the people.
Expecting similar returns consistently from the stock markets is one of the common mistakes. This happens when expectations from the market are unrealistic (like doubling money in 1 year. etc).
The other side is when there is fear in the markets there perception that markets are extremely risky and all investments should be moved to safe instruments like FD’s etc.
Point is :
Markets test patience and reward conviction.
1. Equity Markets cannot keep rising 100% year on year every year & cannot keep falling 50% year on year every year.
2. There are various phases to the markets, long periods of range bounded ness, sudden spurts either up or down due to sentiments, global factors etc. All this causes violent moves in the markets in short term. In the long run or long periods of time 5yr, 10yr, 15yr the ups and downs and returns from the marketseven outtoyield mean (or average) realistic returns. Being aware of this point is important.
3.Riskin equity marketsappears very highin short period of time. HoweverRisk in Equity markets is reduced significantly when investments are spread over long periods of time.
4. Risk and Returns are inseparable. Once the objective is clear which is get better returns over a period of time, then you must be willing to invest in instruments which carry more risk, intelligently. And marry the risk with passage of time to yield good returns.
#7. Leaving Investments in Auto Mode – No Periodic Assessment, No periodic Re balancing
You do periodic health checkup with the objective of finding if there is any need to take preventive measures to keep the body in good shape. If you are gaining weight and becoming overweight, you need to start taking steps to cut down on the weight. Similarly, if you are losing weight and have become underweight, you need to start taking steps to regain health.
Similarly, periodic assessment of portfolio (once a quarter, every 6 months at least) is necessary. This has to be done with the similar objective of taking preventive measures (if at all required) to keep the portfolio in good shape. Portfolio rebalancing has to be done as per asset allocation.
However, many investors make mistake of leaving the portfolio in auto mode once the investments have been made. Investments is indeed a long term process, but If some investment goes sour, and it is not acted upon in a timely manner, it probably becomes too late / or too costly to get the portfolio back on track , if preventive measures are not planned and executed.
Final Part to be contd…… You can read the final installment here at Part IV