Equity Indices are the most traded derivatives in the world. Based on data from over 75 derivative exchanges across the globe, equity index clocked the highest volumes in 2019[i]. While equity indices did over 10.5 billion, individual equity was a distant second at 5.05 billion, while interest rate, currency and energy followed at 3rd, 4th and 5th positions with 4.06 billion, 3.3 billion and 2.1 billion respectively. Also, the growth of equity index volumes in 2019 over 2018 was a phenomenal 30.5%. Meanwhile, in 2019, NSE surpassed America’s CME Group Inc. to become the world’s largest derivatives bourse by volume. In FY18-19 and in FY19-20 derivatives turnover grew by 44% and 45% respectively. By mid of December 2020, derivatives turnover in NSE had equalled that of the full FY19-20 and with more than four months to go, it would not be surprising to see the growth rate of last two years being surpassed.
The index derivative field in NSE is an extensively and intensively traded space. Since the launch of weekly contracts, the overall trading volumes have risen, but in place of the monthly, the volumes are now concentrated on the weekly, especially the nearest to expire. This has also meant that the trading behaviour has also changed, with traders focusing on one week at a time, while also allowing traders to take advantage of the time decay plays at least four times a month. Consequently, though the monthly contracts of both Nifty as well as Nifty Bank have reasonable trading activity, they have found lesser attention, attracting volumes only in the second half of the month. Meanwhile, traders lost interest in the Nifty IT index derivatives and it failed to satisfy the prescribed criteria required to keep them running, leading to the exchange discontinuing them.
It is into this midst that derivatives for financial services index are being introduced from 11th January 2021. Let us see what it brings to the table.
Welcome: Financial Services Index derivatives
The Nifty Financial Services Index is designed to reflect the behaviour and performance of the Indian financial market which includes, financial institutions, housing finance, insurance companies and other financial service companies. It comprises of 20 stocks that are listed on NSE.
End of the road for Bank Nifty?
Something has got to give. When T20 was launched, cricket stakeholders were unconvinced as to whether the other two formats, namely Test, as well as One Day can co exist with it. The prime argument was whether the viewership preferences of the new audiences of the shorter format that T20 is, will affect the prospects of Test as well as One Days, both longer formats. Another important argument was possibilities of player burnout, as well as the difficulty in squeezing T20 into the already crowded playing calendar. As it turns out, the weak formats have survived, and the good ones flourished, while the cricket fraternity adjusted to the new world order. The same could be said about the derivatives space too. It is still in the growth phase, and can very well accommodate a new entrant. According to recent investment data of foreign portfolio investors (FPIs)[ii], 48 percent of new investment flows were channelised into the financial services sector. The sector accounted for 35 percent of the assets under the custody, and many of the Mutual Fund AMCs have schemes tracking this sector.
Now the question is whether the new derivatives have the potential for nudging out existing ones.
For the trend trader, there is a convincing reason. The Nifty Financial Services Index has a 0.98 correlation with Bank Nifty, as it also has the top 3 constituents of the Bank index. And, the correlation with Nifty is 0.94, while that of Bank Nifty with Nifty is 0.92. Hence, for those looking for a proxy to Nifty, or to ride an overall upbeat mood in the market, then it would be better to trade the fin nifty index. The 5 year performance is also in favour of the fin index, which returned 14.99% when compared to the 11.18% that the bank index returned in the same period.
But, long term returns is not a fair measure of an index derivative especially as it sees more volumes on a weekly basis. This is where volatility becomes an important statistic, which is actually a desirable characteristic for the option trader. Volatility, as measured by standard deviation, for one year was 40.86 for the fin index, while that of bank nifty was 42.68 for the same period. Beta with Nifty 50 was 1.23 for the fin index, while it was 1.27 for the bank index. So, while the bank nifty is clearly more volatile than the fin index, it does not hold that advantage by a margin sizeable enough to be a decision breaker. Hence it may boil down to familiarity. However, for the option trader, the fin index does have a new set of toys to play with, as below.
What is new?
The exchange said it will offer futures and options in four serial weekly and three serial monthly contracts, excluding the monthly expiry. This is the first time, that the exchange will make available weekly futures for the stock index derivatives. This would open up a set of option plays that involves futures, calls and puts, which may not have been as feasible with the monthly futures and options.
Tail piece: There is absolutely no doubt that Indian traders are coming of age and index derivatives have played a huge part. This popularity is also attempted to be tapped by launching of new indices like the bulldex in the commodity segment and the soon-to-be launched financial services index in the equity segment. Hence, it is of no surprise that SEBI is also thinking in terms of creating an overarching framework for indices and compliance standards for index providers, in line with proposals from International Organization of Securities Commissions (IOSCO). This could potentially provide greater level of disclosure and transparency, as well as to promote the reliability of benchmark determinations, and address benchmark governance and accountability mechanisms. A consultation paper on the same has been placed on the public domain and is available on the SEBI website.