2010 set to be year of indices trading

2010 set to be year of indices trading

A fixed-income index, a volatility index and indices of commodities and weather (rainfall, temperature and moisture) will be available for trading from 2010.

An index is an indicator of market movement and a hedging tool. Currently, trading happens only in equity indices. The National Stock Exchange, which is the world's third-largest derivatives trading platform, is developing an index of fixed-income securities in a joint venture with Standard & Poor's.

Market participants say trading in a fixed income index will be successful once interest rate futures, an illiquid instrument, gains momentum. A fixed-income index reflects movement in interest rates.

"We are developing some more indices through our JV with NSE, called IISL," Deven Sharma, chairman, Crisil, said.

NSE is working on launching VIX, developed under licence from S&P. S&P developed VIX for the Chicago exchange, too.

Volatility is decided based on trading in options contracts. "Volatility is inversely related to the market. In a range-bound market, chances are that volatility will come down if the market is at the lower end of the range and a trader can short VIX once the market moves up," said Sidharth Bhamre, head (derivatives), Angel Broking. The volatility index could also be used as a hedging instrument by index traders, he added.

Trading in commodity and weather indices would be a reality once amendments to the Forwards Contract Regulations (FCR) are passed in Parliament in the coming months. If an investors/trader wants to invest in commodities, but doesn't know which commodity would go up, he could buy into an index. For example, in case of drought, agro commodity prices tend to move up and, hence, one can buy into the agri index.

"Existing commodity exchanges like MCX and NCDEX are prepared to launch trading in indices. If all go well, commodity index trading will start in the early second half of 2010," P K Singhal, deputy managing director of MCX, said.

"It will help in diversification of portfolio and offer a broader basket to hedge, using a single product. Globally, institutional participants such as banks and asset management companies hedge their risk in commodities using indices, as they can select the structure and composition of the index," he added.

A weather index is useful for various industries, apart from farmers and traders. The Chicago Mercantile Exchange has several weather indices like rainfall index, temperature index and even moisture index.

Commodities and industries can hedge on such products. For example, cement sales come down if rainfall is high, so cement manufacturers can go bullish on the rainfall index (expecting more rain) and make money there, which will compensate for lower sales in cement due to slower construction.

If the monsoon turns deficient, they will lose money on the rainfall index, but will get compensated by higher cement sales, as construction work will be on fast track. Fertiliser companies take a reverse call, as their sales go up if rainfall is higher. In many cases, quantum of rainfall or temperature is important and, therefore, trading in such indices helps.

Ice cream sales can fall if temperature is low. The wheat crop benefits if winter is cooler. In case of traders, they can simply go long in such indices if they feel the monsoon will be better.

Indices also provide investment opportunities in commodities, as actual buying and selling commodities require investors to go through various formalities like tax and deliveries.