Index Futures are futures contracts that are traded based on a sectoral index or overall market index. For instance, you could simultaneously trade in Nifty futures (a market-wide index) and Bank Nifty’s (sectoral index) liquid futures. Both these indices, being highly liquid, are preferred for active trading by both institutional and retail investors.
With Stock Trading App gaining prominence in India, index futures trading has also evolved as a by-product of stock futures trading.
Does this mean trading in index futures is beneficial for traders? Let us first explore the benefits of trading in index futures to evaluate how index futures can benefit traders.
1. Get an overall outlook for mitigating risks
Due to market volatility, stocks provide high returns, but they also entail high risks. For instance, bank stocks are popular among investors. However, you need to identify the right kind of stock to get maximum returns, as public sector banks have NPA issues and private sector valuation challenges. To mitigate risks, you can purchase Bank Nifty Futures as they give a consolidated view of the overall bank sector, aiding diversification and position roll-over each month.
2. Undertake both long side and short side trading
A key benefit of trading in index futures is that you can trade both ways. For example, Indian markets have rolling settlements, which means that they allow only the short side (equities) for intraday trading. To avoid such issues, the best option would be to trade in the index futures of Bank Nifty, where you can get both long and short trading positions.
3. Index futures can be traded even with low margins
Index futures like the Nifty trade lower than individual stock margins, owing to the index offering diversification across stock combinations. This means that you undertake lower risk due to the low margin needed for having an index futures position. Also, you will invest less money.
4. Index futures allow hedging risk
A trader or institutional investor is privy to holding a huge stock portfolio. However, market volatility could make stock prices go up and down. In such a condition, you can hold the stock. Or you can hedge the stock risk by undertaking a sell on Nifty futures. That means, when there is a fall in the market, book profits on Nifty futures. This means that your average cost of holding equity will get reduced, thus mitigating risk.
5. Index futures have limited liquidity risk
Index futures have minimal liquidity risk, apart from narrow bid-ask spreads. This makes them a safe trading option.
6. Index futures help diversify your portfolio
Index futures aid in structural diversification of your portfolio, like having index futures of the FMCG index and IT index. This gives you a broader investment outlook, thus mitigating risk.
7. Low index futures trading cost
Compared to equities or stock futures, index futures’ commission and STT rates are lower.
Therefore, trading in index futures has lower risk and greater return over time. With online stock trading as the norm, the future looks bright for index futures.