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.