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New Indices: Mini Contracts

New Indices

The New Year has set in and is bringing with it a lot of new things. Amongst many events in the financial sector - like the Reliance Power IPO and the market crash - 2008 may well see the launch of two new indices. They will not be sector indices like the recent Power Sector index. We are talking of a Volatility Index and the Dharma Index.


Volatility Index

The Volatility Index will be launched by the Bombay and National Stock Exchanges (NSE). The exchanges have been given a green signal by the market regulator, Securities & Exchange Board of India (SEBI), to go ahead and launch the index. At the same time, SEBI has also given the exchanges a free hand to decide whether they want to adopt a global model for this index or develop their own model. The Volatility Index, along with Futures and Options on it, was a recommendation by the SEBI-appointed Derivatives Market Review Committee (DMRC).

The Volatility Index will measure market expectations of near-term volatility conveyed by the prices of stock index options or a basket of options on stocks. Don't worry if you can't figure out what that means. According to a SEBI circular, a detailed methodology of the Volatility Index would be distributed by exchanges for the benefit of investors.


Dharma Index

The other index that may come up this year is the Dharma Index. This one is targeted at Hindu and Buddhist investors. The Dharma Index is being developed by Dow Jones and a private investment company, Dharma Investments (hence the name). The stocks in this index will be screened on the parameters of environment and corporate governance. The environment screens will take into consideration factors like emissions by the company and waste management measures while the corporate governance screens will consider factors like labor relations, industrial disputes, working conditions and wages.

The constituents of this index will be reviewed on a quarterly basis. While it is not clear as to exact date of launch of these indices, one thing is for sure, the indices will give investors something to think about and provide a different angle to investing.


Mini Contracts


The one that has been out of the reach of the small retail investor has been the derivatives segment. This segment has always been a place for the big ticket size investors who look to multiply their wealth by paying just marginally for their purchases. This is an extremely high-risk segment, especially in the futures section where the profits and losses can be limitless. This has been due to the big lot size involved and the high margin money required to be paid up front. And as a result, a majority of the trading done on the bourses everyday is in the derivatives segment, whereas the cash segment gets a minuscule share.


To change this scenario and increase participation of retail investors, the Securities and Exchange Board of India (SEBI) has allowed smaller sized contracts to be introduced. Subsequently, the National Stock Exchange (NSE) launched the mini-Nifty contract and the Bombay Stock Exchange (BSE) launched the 'Chhota Sensex'. As the name suggests, these are small lot size contracts with a lot size of five (Chhota Sensex) and 20 (mini-Nifty).

These new contracts will give the smaller retail participants an option to enter the derivative segment with lesser money. These contracts would involve lower trading costs and lower capital outlay (for margin). Investors would also benefit from better and precise hedging, flexible trading options and more arbitrage opportunities.


The security symbol for the smaller Sensex contracts is MSX and for the mini-Nifty contract is MINIFTY. The contracts would be available for monthly and weekly options just like existing future and option (F&O) contracts. SEBI has allowed trading in these contracts with effect from January 1, 2008. The value of a contract for a Nifty with lot size 50 is around Rs 2.5 Lakh. Hence the margin involved is also high. However, in the mini-Nifty contract, the lot size is 20 and the value of one contract will be around Rs 1.2 lakh. Likewise, the margin for a contract on Sensex was around 45,000 when the lot size is 25. For mini-Sensex the lot size is only 5 and the margin will be around Rs 9,000.

To make this a further attractive trading option, the NSE has even waived the transaction charges on all of its mini-Nifty contracts till March 31, 2008. This move was specifically targeted as the turnover on the smaller Sensex contracts was noticed to be higher than that on mini-Nifty in the initial days. This was surprising as generally the turnover on NSE F&O segment is much more than BSE. But before retail investors take the plunge and start experimenting, they should be aware that the derivatives segment can prove to be extremely risky. Futures and option require proper knowledge, guidance and a high risk appetite.

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