NSE Research Paper: Hedging Effectiveness of Stock Index Futures
With the imminent launch of futures and options contracts on two key NSE indices - the CNX NIFTY JUNIOR (JRNIFTY) and CNX 100 (CNX100) - here is a relevant & timely piece of research published by the NSE: Optimal Hedge Ratio and Hedging Effectiveness of Stock Index Futures.
A hedging strategy is effective only if the mean return from the strategy is higher than the competing strategies and it reduced a significant portion of the variance with respect to its unhedged strategy.
The conventional naïve strategy of 1:1 position for hedging has faced several criticisms as the spot and futures prices behave differently.
As for the soon to be launched mid-cap index derivatives, check Deepak’s post on how the underlying stocks might be impacted.
The one wrinkle in this is the absence of 12 common stocks in both the indices, which are not part of the single-stock futures list. As this ET article explains:
The absence of these 12 stocks in single-stock futures will create an imperfect situation for investors who intend to take advantage of the mispricing between the index futures and the basket of stock futures constituting these indices.
So, hypothetically, if the Nifty Junior futures are trading at 8100, the basket of 50 single-stock futures should be somewhere close to the index futures. In the absence of the 12 components, the basket comprising the remaining 38 stocks would not reflect the actual pricing of the index. To reduce the pricing imperfection, an investor would have to hunt for stock futures with similar weightage to fill up the gap.
The combined weightage of the 12 stocks in the Nifty amounts to almost 17%.
The 12 stocks are: Apollo Tyres, Asian Paints, Aventis Pharma, Biocon, Container Corporation of India, IBP, ING Vysya Bank, Ingersoll Rand, Nirma, Punjab Tractors, Raymond and Tech Mahindra.
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