The Stock Exchange, Mumbai created history by launching the first Exchange traded Financial derivatives product in India, the Sensex Futures. The inauguration of trading was done by Prof. J.R. Varma, member of SEBI on June 9, 2000.
About Index Features
An Index is a number used to represent the changes in a set of values between a base time period and another time period.
Stock Index represents change in the value of a set of stocks, which constitute the index, over a base year. Any Index is an average of its constituents. For example, the BSE Sensex is a weighted average of prices of 30 select stocks and S&P CNX Nifty of 50 select stocks, where the weight is the market capitalization of individual stocks.
Methodologies in Calculating the Index
Most indexes are capitalization-weighted. Number of shares issued to outstanding multiplied by the market price of company's share determines its weightage in the index. The total of market capital of all shares in the index is linked to an index number. The shares with highest market capitalization are most influential in this type of index. To conform to the ground reality, this is suitably adjusted. In the first place the number used as outstanding shares is adjusted to reflect only those shares that are freely available for trade (floating stock) ignoring those shares which are not expected to be traded in the market (like promoters holding).
Secondly the influence of the largest stocks in the index, which otherwise would dominate the entire index is moderated. This is done by setting a limit on the percentage weight of the largest stock or a group of stocks.
This type of index sums up the price of each stock in the index, which is then equated to an index starting value. The shares with the highest price are not influential in this type of index. If a stock splits, its market price falls resulting in less weight in the index. Each Stock's percentage weight in the index is equal and therefore all stocks have equal influence on the index movement.
Uses of Stock Indices
A market Index is very important because of the following reasons:
It acts as a barometer for market behavior
It is used to benchmark portfolio performance
It is used in derivative instruments like Index futures
It can be used for passive fund management as in case of Index Funds
The underlying
An index is an indicator of the broad market. For instance, tracking the changes in the Sensex enables one to effectively gauge stock market movements. The BSE 30 Sensex, first compiled in 1986 is a market capitalisation weighted index of 30 scrips. It represents 30 large well-established and financially sound companies. The Sensex also has the largest social recall attached with it. It was the first index to be launched by any Stock Exchange in India and has acquired a unique place in the collective
The most important advantage is that, as one of the oldest and reliable barometers of the Indian Stock Market, it provides time series data over a fairly long period of time. The primary consideration in minimising changes in the composition of the BSE 30 has been for historical purposes. However, the structural and market driven changes are taken into consideration. While an index must represent the current state of an evolving market, it should concurrently maintain the track record of changes in the Indian capital markets. The Sensex represents a broad spectrum of companies in a variety of industries. It represents 14 major industry groups which are large enough to be used for effective hedging. Given the lower cost structure and the overwhelming popularity of the Sensex, Sensex futures is expected to garner large volumes.
Unique Features of Sensex Futures
The Sensex futures would evolve to become the most liquid contract in the country. This is because Institutional investors in India and abroad, money managers and small investors use the Sensex when it comes to describing the mood of the Indian Stock markets. Thus is has been observed that the Sensex is an effective proxy for the Indian stock markets. Higher liquidity in the product essentially translates to lower impact cost of trading in Sensex futures. The arbitrage between the futures and the equity market is further expected to reduce impact cost. Trading in Stock index futures is likely to be pre-dominently retail driven. Internationally, stock index futures are an institutional product with 60% of the volumes generated from hedging needs. An immense retail participation to the extent of 80 - 90% is expected in India based on the following factors :
Stock index futures will require lower capital adequacy and margin requirements as compared to margins on carry forward of individual scrips.
The brokerage costs on index futures will be much lower.
Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms.
The impact cost will be much lower in case of stock index futures as opposed to dealing in individual scrips.
The market is conditioned to think in terms of the index and therefore would prefer to trade in stock index futures. Further, the chances of manipulation are much lesser.
The Stock index futures are expected to be extremely liquid given the speculative nature of our markets and the overwhelming retail participation expected to be fairly high. In the near future, stock index futures will definitely see incredible volumes in India. It will be a blockbuster product and is pitched to become the most liquid contract in the world in terms of number of contracts traded if not in terms of notional value. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more depth, volumes and act as a stabilising factor for the cash market.
Derivatives market data is available on the Derivatives Trading and Settlement System (DTSS) under the head market summary. This terminal is provided to all members of the Derivatives Segment. Non-members can have access to the same information via the financial newspapers or from the Daily Official List of the Stock Exchange.
Introducing Limited Trading Membership for BSE Derivatives Segment
As per the Rules of the Derivatives Segment, only a member of the Exchange (the Cash Segment), can become a Trading Member on the Derivatives Segment. The Exchange has received representations for admitting new members only for the Derivatives Segment who may be desirous of trading only on the Derivatives Segment and not on the Cash Segment.
In view of the aforesaid representations, The Exchange decided to offer Limited Trading membership exclusively for the Derivatives Segment of the Exchange. The same has been approved by SEBI also.
This development has made the futures market accessible to those who are not members of the Exchange and are desirous of participating in the Derivatives market. The Trading Members so admitted will not have the rights and privileges conferred on a member of the Exchange, but would be bound by the Rules of Derivatives Segment of the Exchange. Such Trading Members, with Limited Membership Rights, would be required to be registered with SEBI as trading members and would have to satisfy all the eligibility conditions specified by SEBI as per the recommendations of Dr. L.C. Gupta Committee Report.
A person need not be a member of the Exchange in order to apply for registration as a Limited Trading Member. A Limited trading member shall be a trading member in all respects and for all purposes and shall have all the rights, privileges, obligations & liabilities of a Trading Member and the rules, Regulations, Business requirement specifications, guidelines & other provisions of the Derivatives Segment, the Exchange, & SEBI shall be applicable to a limited trading member as they apply to any other Trading Member. Such Limited Trading Member shall not be entitled to be a member of the Derivatives Governing Council or any other board, council or committee of the Derivatives Segment, the Exchange or any other segment of the Exchange.
