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How to trade in Nifty Futures in a Volatile Market

3 Mins 17 Feb 2021 0 COMMENT

Stock market volatility can hit even the best-laid trading plans. Will your trading strategy help you tide over the sharp price swings and fetch profits? It might—particularly if you plan on dealing in stock index futures contracts like the highly traded Nifty futures. If you list the top traded index futures globally, Nifty futures would be right up there.

Basics of Trading Nifty Futures

Nifty50 is the National Stock Exchange (NSE) benchmark representing the top 50 companies traded on the exchange.  

But you cannot trade Nifty like an individual stock. That’s where Nifty futures come into play. Here, the value of the futures contract is derived from the underlying asset—the Nifty index. The buyer and the seller of a futures contract agree to exchange the contract's cash value by specified expiration date.

Nifty Futures in Times of Volatility

Wildly fluctuating prices and stock market uncertainty can unsettle even seasoned traders. Nifty futures could offer some advantages at such times:

  • High liquidity: Nifty futures are among the most widely traded futures contracts in India. With traders always ready to buy Nifty futures in large quantities, it is easy to fill orders at your preferred price.
  • Diversification: Nifty50 is a portfolio of 50 diversified stocks. Even if a few individual stocks move adversely, the others prop up the index. That cushions the impact on the overall index.
  • Low risk of manipulation: Since Nifty represents a group of stocks, it is harder for unscrupulous traders to manipulate the prices. The prices of individual stocks are relatively easier to push up or pull down.
  • Low margins: When you trade Nifty futures, the average margin requirements are lower at 12% to 15%. But in case of individual stocks, you may face margins as high as 60%.

Risk Protection with Nifty Futures

Say, you have Rs 9 lakh invested in nine different stocks. Amid sharp price fluctuations and general market uncertainty, you are worried about the risk to your portfolio. But there is a way to mitigate that risk: you could hedge using Nifty futures.

Suppose Nifty is trading at Rs 11,500. The current lot size for a Nifty futures contract is 75. This means that the contract value per lot will be Rs 11,500 x 75 = Rs 8,62,500. So, you could sell one lot of Nifty futures as a hedge to protect your stock portfolio against adverse price movements. It does not cover your entire Rs 9 lakh of stock investment, but it comes reasonably close.

Now, two scenarios might play out:

a)    Let us assume that the Nifty moves up from its current levels. Since you have sold Nifty futures, you may face losses on your transaction. However, your stock portfolio will have appreciated as a result of Nifty's rise.

b)    Now, the Nifty moves down from its current levels. That will pull down the value of your stock portfolio, but your hedge will pay off. Since you had already sold Nifty futures, you can draw profits on closing your position.

In both scenarios, the hedge using Nifty futures helps safeguard your current positions. It also carries some potential for gains.

Use Volatility to Your Advantage

Volatility in the futures market can be a good thing. That is because pinpointing entry and exit positions may be more straightforward. The right set of strategies can fine-tune your trading plan and help you gain from a volatile market. Here are some pointers to add to your trading arsenal:

  • Assess the premium: When trading futures, always check the monthly spread about the spot price. The spread usually reflects the cost of the underlying assets. The price of futures contracts usually adds a premium to this. If you are dealing in Nifty futures, think twice if the premium is too steep. Excessively high premia are often a sign of overpricing. You may also want to steer clear if Nifty futures are going at discounted rates. It may be indicative of aggressive selling.
  • Factor in your leverage: Volatile markets are hard to predict. So, keep your exposure in mind. You can buy Nifty futures with ten times the exposure in regular trades and 20 times the exposure when intraday trading. If a trade does well, the leverage ensures that your profits will multiply. But you may want to plan for the worst-case scenario as well—should a trade move adversely, it would magnify your losses.
  • Review open interest: The open interest data indicates how many futures contracts are currently open in the stock market. Together with the price, it can help you assess whether more trades are going long or short. Be wary of very high open interest accompanied by a sharp rise or fall in the Nifty futures price. That is often a sign of excessive optimism or pessimism in the market.
  • Study the liquidity: Although Nifty futures are highly liquid in general, you could face liquidity issues at times. For instance, as trades get closed on the expiration date, the usual volumes may drop. Plus, if the market is in sharp decline, the price spread may extend considerably, thereby hurting your trades.
  • Factor in overnight risk: This remains a concern at all times, but especially in a volatile market. Even if you have a stop loss in place, it may not get triggered in time if you have taken a long position on Nifty futures and the market crashes on opening.
  • Consider the counterparty: Every futures contract involves two parties—a buyer and a seller. While you may have good reasons for going long or short on Nifty futures, it is a good idea to consider how your counterparty hopes to gain from the trade. That will help you to make more effective choices on the bourses.

Summing Up

The inherent advantages of Nifty futures can come in handy amid volatility. As a trader, you must study the data and employ charting tools to make informed decisions. Just make sure to keep your exposure under control and factor in each trade's costs and commissions. Happy trading!