What is an index?
An index is a method which is used to track the overall performance of stocks in the stock market. An index is typically categorised based on the market capitalization of the company e.g. Nifty 50 index contains the 50 biggest companies in India or Nifty next 50 index which contains the 51st to 100th biggest companies. An index can also be categorised based on the industry in which the stocks belong such as Nifty Bank which contains the biggest banking stocks in India. The performance of the index shows the performance of the stock market as a whole (or of the industry in case of sectoral index). The performance of the Indian stock market as a whole is generally measured using the performance of Nifty 50 index or Sensex index.
Example of an index & its constituents
Nifty 50 is the most tracked index in the Indian stock market. It contains the 50 biggest companies in India as per the market capitalization. The Nifty index contains the weighted average of these 50 stocks with the biggest heavy weights being companies like Reliance Industries, Infosys, TCS, HDFC Bank, etc. This information about the Nifty 50 index can be found on the NSE official website. The current top 10 companies of Nifty 50 are as follows (data of December, 2021)
Since the Nifty index is composed of 50 companies, the price of Nifty depends on the prices of the individual stocks (especially the top 10 heavyweight companies). If heavyweight companies like Reliance, TCS, Infosys & HDFC bank are highly bullish, then Nifty is highly likely to be bullish.
What is index management?
Index management is the act of controlling an index at a particular level which is generally performed by big funds such as FIIs or DIIs. Index management happens before or on the expiry date of the F&O contracts.
Let’s consider an example. Suppose Nifty index is trading at 17,000 points. If big funds start buying Nifty stocks to increase Nifty index, this will benefit put sellers & call buyers. On the other hand, if big funds start selling Nifty stocks to decrease the Nifty index, this will benefit put buyers and call sellers. This is of utmost importance in short term because the outcome of the F&O expiry depends on the price on the index on the day of expiry. And the price of the index decides the winners and losers of options trading on the day of F&O expiry (F&O expiry occurs every Thursday for weekly options & on the last Thursday of the month for futures & options)
Why would anybody do index management?
Index management is done to benefit a select group of F&O traders, generally big funds like FIIs & DIIs. The act of controlling the index until the F&O expiry day ensures that a select group of F&O traders are profitable.
Let’s consider an example. Suppose Nifty 50 is trading at 17,000 points on Monday. Many bullish big funds have sold Nifty PE 16,900 (Nifty put option with the strike price of 16,900). At the same time, many bearish big funds have sold Nifty CE 17,100 (Nifty call option with the strike price of 17,100). This means that the bullish big funds will start losing money as Nifty falls below 16,900 and the bearish big funds will start losing money as Nifty rises above 17,100. This leads to a tug of war between the bulls and the bears which gets settled on the expiry day (which is every Thursday for the weekly options). If you don’t know how put & call options work, visit this article!
Bullish big funds will start buying Nifty 50 companies with a clear goal of not allowing the index to fall below 16,900 points. Bearish big funds will start selling Nifty 50 companies with a clear goal of not allowing the index to move above 17,100. The buying and selling of stocks near the expiry day has nothing to do with the fundamentals of the company, rather it is done to control the index in order to benefit a select group of F&O traders in the short term.
Conclusion
A battle between the bulls and bears happens regularly in the stock market which concludes on the day of the F&O expiry. Long term investors do not care about the short term volatility on the expiry day because the stock prices tend to align with the fundamentals of the company in the long term. Traders, especially those who trade in Indices need to be aware of the short term direction of the market to make sure that they are on the winning side of the trade. It is not possible for small investors to control any indices in the stock market. It is prudent to simply join the winning side! However, the final decision for trading and investing depends on the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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