Futures and options trading on Nifty Next 50 commenced on April 24, 2024. Will this impact the index and, therefore, its passive investors (via index funds and ETFs) in any way? In particular, how will F&O trading impact the volatility and liquidity of the underlying index (or its constituent stocks in the spot market)?
The spot and futures markets are linked via arbitrage. The spot price of a stock is its current price. This is the price quoted in business channels and financial portals. When you buy or sell a stock using a demat account, the stocks are delivered or off-loaded immediately at the applicable price when purchased or sold.
In the futures market, buyers and sellers do not exchange stocks (or commodities) immediately. The stocks change hands at a future date, but the price is fixed at the time of agreement. Thus, a contract is arrived at. The contract price per stock can vary daily, and the contract can be traded in the futures market.
A difference between the stock price in the futures market and the spot market is referred to as an arbitrage opportunity. This difference arises due to the inefficient flow of information between the two markets and is temporary.
The difference decreases as the due date of the futures contract expiry nears, and the prices tend to become the same. More arbitrage opportunities are available when the markets are volatile.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
People would prefer the former if the futures stock price is lower than the spot market price. The increased demand will increase the futures stock price. There would also be pressure on the spot stock price to decrease. Soon, the two prices will converge.
Thus, although the price difference (arbitrage opportunity) may exist at one point, it will diminish rapidly. For an example of how mutual funds profit from this, see How Arbitrage Mutual Funds Work: A Simple Introduction. This is depicted in the cover image of the Parag Parikh Arbitrage Fund Flyer.
![Partial cover image of the Parag Parikh Arbitrage Fund Flyer Partial cover image of the Parag Parikh Arbitrage Fund Flyer](https://freefincal.com/wp-content/uploads/2023/10/Parial-cover-image-of-the-Parag-Parikh-Arbitrage-Fund-Flyer-e1714019466587.jpg)
Will F&O trading on Nifty Next 50 impact index investors?
The short answer is that it may decrease the volatility of the Nifty Next 50, but we cannot say for sure as the opposite may also happen! Yes, that is disappointing, but that is how the cookie crumbles.
There are theoretical arguments supporting both sides! Some expect a decrease in volatility because speculators would move from the spot market to the futures market. Some predict an increase in volatility in the spot market due to the participation of uninformed traders in the futures market and the supply vs demand mismatch in the futures market.
There is plenty of empirical evidence supporting both sides! Sometimes, results from indices of the same country do not match! A study published in the Reserve Bank of India Occasional Papers Vol. 24, No. 3, Winter 2003 says, “‘futures effect’ plays a definite role in the reduction of volatility in the case of S&P CNX Nifty, in the case of
BSE Sensex, where derivative turnover is considerably low, its role seems to be
ambiguous”.
That said, studies that support a lowering of volatility form the majority.
A more recent study by P Sakthivel concludes, “Futures’ trading reduces spot price volatility by providing low contingent strategies and enabling investors to minimize the portfolio risk by transferring speculators from the spot market to the future market. The low margins, transaction costs, standardized contracts, and trading conditions attract risk-taking speculators to the futures market. Hence, futures are expected to have a stabilizing influence as they add more traders to the cash market, making it more liquid and, therefore, less volatile”. Article references for other markets can be found in this publication.
So let now go with the majority finding and assume/expect that introducing F&O trading will reduce the volatility of the Nifty Next 50. This means the risk premium and expected returns may also be reduced.
Already, there is some evidence (though far from conclusive) that the Nifty Next 50 has become less volatile due to increased investor participation. Until a few years ago, the Nifty Next 50 had a risk and reward profile similar to Nifty Midcap 150. After the March 2020 crash, the Mid cap index pulled away. See Nifty Midcap 150 beats Nifty Next 50 for the first time.
Also, see more recent data here: Nifty vs Nifty Next 50 vs Nifty Midcap 150 vs Nifty Smallcap 250: Return Comparison April 2024.
![10-year rolling returns of Nifty Midcap 150 TRI and Nifty Next 50 TRI as of April 2024 10-year rolling returns of Nifty Midcap 150 TRI and Nifty Next 50 TRI as of April 2024](https://freefincal.com/wp-content/uploads/2024/04/10-year-rolling-returns-of-Nifty-Midcap-150-TRI-and-Nifty-Next-50-TRI-as-of-April-2024.jpg)
Will introducing F&O trading further reduce the risk premium of Nifty Next 50 compared to Nifty Mid cap 150? Yes, this is possible (I am not saying it will or will not; I am just appreciating that it is possible).
Does this mean a Nifty Midcap 150 index fund is a better choice than Nifty Next 50 if I wish to beat the Nifty 50 (aka “diversification”!)?
There is only one aspect that stops me from saying yes. Nifty Midcap passive funds (index funds or ETFs) have not yet seen a market crash or sustained bear market. How efficiently a fund manager can handle these situations is largely untested.
Therefore, our recommendation (at least for the time being) remains the same:
- Investors should stick to a simple Nify 50 or Sensex index fund. Nothing more is needed.
- If there is a sense of FOMO, then a small exposure of Nifty Next 50 is sufficient. This can be frustrating to hold from time to time, but that is also true of the mid cap index.
- See Handpicked List of Mutual Funds (PlumbLine) for our fund recommendations.
If the data changes, we will be happy to revise our opinions.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
![Follow Freefincal on Google News Follow Freefincal on Google News](https://freefincal.com/wp-content/uploads/2023/07/Follow-Freefincal-on-Google-News.jpg)
![Subscribe to the freefincal Youtube Channel Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.](https://freefincal.com/wp-content/uploads/2023/07/Subscribe-to-the-freefincal-Youtube-Channel.jpg)
![Follow freefincal on WhatsApp Channel Follow freefincal on WhatsApp Channel](https://freefincal.com/wp-content/uploads/2023/09/Follow-freefincal-on-WhatsApp-Channel-300x83.jpg)
![Listen to the Lets Get Rich with Pattu Podcast Listen to the Lets Get Rich with Pattu Podcast](https://freefincal.com/wp-content/uploads/2023/07/Listen-to-the-Lets-Get-Rich-with-Pattu-Podcast.jpg)
![Lets Get RICH With PATTU podcast on YouTube Lets Get RICH With PATTU podcast on YouTube](https://freefincal.com/wp-content/uploads/2023/08/Lets-Get-RICH-With-PATTU-podcast-on-YouTube-644x362.jpg)
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
![Pattabiraman editor freefincal](https://freefincal.com/wp-content/uploads/2019/11/Pattabiraman-author-freefincal-article-bottom.jpg)
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
![Both boy and girl version covers of Chinchu gets a superpower](https://freefincal.com/wp-content/uploads/2021/02/Article-bottom-Chinchu-gets-a-superpower-front-cover-for-girls-and-boys.jpg)
![Feedback from a young reader after reading Chinchu gets a Superpower (small version)](https://freefincal.com/wp-content/uploads/2021/02/For-bottom-Feedback-from-a-young-reader-after-reading-Chinchu-gets-a-superpower.jpg)
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
![You can be rich too with goal based investing](https://freefincal.com/wp-content/uploads/2016/11/You-can-be-rich-243x300.jpg)
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
![Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you want](https://freefincal.com/wp-content/uploads/2017/05/2-mini-Cover-pink.jpg)
Your Ultimate Guide to Travel
![Travel-Training-Kit-Cover-new](https://freefincal.com/wp-content/uploads/2019/11/Travel-Training-Kit-Cover-new.jpg)