Time is ripe for domestic markets to have vibrant hedging tools

Time is ripe for domestic markets to have vibrant hedging tools

At the recent Global Economic Policy Forum 2023, organised by the Department of Economic Affairs in Finance Ministry and Confederation of Indian Industry, Ridham Desai, Managing Director, Morgan Stanley India, made three important observations with respect to the stock market.

Desai highlighted that there are a lot of reforms that could be pursued, including opening up stock lending in a big way. “We also need a longer list of single stock futures,” he further said.

Besides, Desai observed that Indian markets still don’t have hedging mechanisms for certain big volatile events such as general elections. “There is no mechanism to do long-dated put,” he said.

Stock lending

Opening up stock lending in a big way at this stage may not help much at this juncture. Similarly, introducing more single stock futures will also not serve the purpose as trading in existing single stock futures is also limited. Besides, a recent study by the market regulator pointed out that 67 per cent traders in stock futures suffered an average loss of ₹2.1 lakh.

However, domestic markets definitely need hedging instruments for certain big volatile events. Though National Stock Exchange does have a long-term options contract on Nifty 50 (introduced in 2008), the activity is less. LEAPS can be more suitable to traders who prefer long-term exposure on indices and for investors who are looking to hedge portfolios. Exchanges and intermediaries such as brokerages and investment advisors should make the options popular through investor education.

What is inverse ETF

However, the most apt products could be inverse exchange traded funds and funds based on volatility index.

An Inverse Index ETF provides the investor an opportunity to create a position which gives inverse (opposite) returns of the index. The index is designed to provide the inverse performance of the benchmark, representing a short position in the index.

Inverse index ETFs are a cost-effective way to express a bearish opinion. They, typically, like any other ETFs , have low expense ratios.

Nifty Inverse index

Though the NSE had launched Nifty50 PR 1X Inverse in October 2014, it was not open to domestic investors. However, investors in Taiwan (through Fubon NIFTY -1 Inverse Index ETF) and Hong Kong (CSOP Nifty 50 Daily (-1x) Inverse ETF) have an opportunity to hedge through these funds. In a bullish market like the current one, these indices typically give negative return. In fact, NSE’s November factsheet revealed that the index has provided a negative return of 9.37 per cent since inception and YTD return of negative 5.27 per cent.

Another product should be Volatility ETFs based on prominent indices. Sadly, NSE was forced to withdraw trading on India VIX (that was launched in 2014) future and options due to lack of trading interest. Derivative contracts on NVIX failed due to its complexity in nature and lack of institutional presence.

Volatility ETFs based on Chicago Board of Options Exchange Volatility Index are quite popular in the US markets.

Perhaps it’s time to refine the features of NVIX and consider introducing a VIX based on other widely-followed indices, such as Bank Nifty and Bank FinNifty, incorporating enhanced features. As derivatives gain popularity on these offerings, the possibility of launching ETFs tied to them emerges, providing investors with effective risk hedging tools.

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