INDEX FUTURE – UNDERSTANDING PREMIUM & DISCOUNT
Nifty Futures is a financial instrument in which futures contracts are done on the basis of CNX Nifty index which is the benchmark of NSE. Nifty Futures keep moving in Premium and Discount compared to Nifty Spot price. We hear a lot of experts talking like NIFTY is available at Discount of 20 points? or Nifty Premium is increasing ? So what does they mean exactly.
>> What is Premium and Discount in Nifty?
Nifty Premium –If Nifty future is trading higher than nifty spot, then nifty future is trading with premium. The Highest Premium seen in Nifty was 70 points in 28 Feb 2012 expiry when market rose 20% in matter on 2 months.
Premium = Nifty Future Price – Spot Nifty Value
For Eg: Suppose NIFTY is trading at 5000 and NIFTY FUTURE is trading at 5020 in this case Nifty is trading in Premium of 20 points (5020-5000)
Nifty Discount –If Nifty future is trading lower than nifty spot, then nifty future is trading with Discount.
Discount = Spot Nifty Value – Nifty Future Price
For Eg: Suppose NIFTY is trading at 5000 and NIFTY FUTURE is trading at 4990 in this case Nifty is trading in Discount of 10 points (5000-4990)
What is significance of Discount and Premium availability of NIFTY?
As per Thumb Rule
>> When discount widens, bearish mood of market is increasing
>> When premium widens, bullish mood of market is increasing
But at times, things can go the other way round also.
>> Sometimes bullishness may also lead to widening of the Nifty futures discount, as explained below:
- When FII’s are long on the markets, they short Nifty futures as a hedge.Nifty Futures are less volatile than individual stocks. If the stocks move up, the loss in the futures will be relatively less.This selling results in huge discount in Nifty Futures.
- Another reason for Discount happens during result season when Companies declares dividends, Large number of index stocks going ex-dividend and it lead to discount in Nifty.
>> Trades should always note when Nifty trades in Premium excessive of 40 points, its a warning bell small correction is round the corner which will lead to lowering of premium in Nifty.
>> Premium and Discounts converges to zero at the closing date of future ie on last Thursday of every month.
STT is levied on every purchase or sale of securities that are listed on the Indian stock exchanges. This would include shares, derivatives or equity-oriented mutual funds units.
The securities transaction tax (STT) was introduced in India a few years ago, to stop tax avoidance of capital gains tax. Earlier, many people usually didn’t declare their profits on the sale of stocks and avoided paying capital gains tax. The government could tax only those profits, which have been declared by people.
To stop this situation, the then Finance Minister P Chidambaram in the Union Budget 2004-05—introduced STT. Transactions in stock, index options and futures would also be subject to transaction tax. This tax is payable whether you buy or sell a share and gets added to the price of the stock at the time the transaction is made. Since brokers have to automatically add this tax to the transaction price, there is no way to avoid it.
The Finance Ministry has supported the introduction of the STT to simplify the tax regime on financial market transactions. According to the ministry, STT is a clean and efficient way of collecting taxes from financial markets. In the words, STT is a neat, efficient and easy-to-administer tax and it has the great advantage of virtually eliminating tax avoidance.
STT is levied on every purchase or sale of securities that are listed on the Indian stock exchanges. This would include shares, derivatives or equity-oriented mutual funds units. The rate of tax that is deducted is determined by the central government, and it varies with different types of transactions and securities. STT is deducted at source by the broker or AMC, at the time of the transaction itself, the net result is that it pushes up the cost of the transaction done.
Scope of STT
- According to the Securities Contracts (Regulation) Act, 1956, STT would be applicable on following securities.
- Shares, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate
- Units or any other instrument issued by any collective investment scheme to the investors in such schemes
- Security receipt as defined in section 2(zg) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
- Government securities of equity nature
- Rights or interest in securities
- Equity-oriented mutual funds
- STT is not applicable for any off-market transaction.
- Finance Minister P Chidambaram in the Union Budget 2013-14 has cut the STT (securities transaction tax) on equities and mutual fund units. STT reduction on ETF is expected to enhance returns with lower transaction costs.
- The STT charge on equity futures is cut from 0.17% to 0.1%. In the previous Budget, STT was slashed by 0.17% from 0.125% on cash delivery transactions.
- The STT charge on redemption of mutual funds or ETFs (exchange traded funds) at fund counters is reduced from 0.25% to 0.001%, while STT on sale of MFs or ETFs on stock exchanges is cut from 0.1% to 0.001% levied only on the seller.
So the next time, your broker or asset management company sends you your transaction bill or statement, remember that the extra bit you are paying over and above your transaction is nothing but the tax that has been levied. Whether it is the purchase and sale of shares or mutual fund units, STT will stay and cannot be avoided. At the end of the year, you can ask your broker to give you a certificate of the STT that you have paid through the year. You can use this amount to deduct from your short term capital gains and get a tax credit.
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