The Nifty 50 is one of India’s broad-market benchmark indices that tracks the price movements of the 50 largest companies listed in the National Stock Exchange. It is widely used by traders to gauge the performance of the stock market as a whole.
One of the primary reasons why the Nifty is considered to be a good indicator of the stock market’s performance is because it covers companies across 14 different sectors. As a result, an investor who invests his capital in the Nifty 50 index can expose themselves to a diversified range of companies and in turn, reduce investment risk considerably.
But then, how should you invest in Nifty? Since it is an index, you cannot purchase it directly like the stock of a company. However, there are other ways in which you can use the index to profit off its movements. This is precisely what we’ll address in this article.
How to trade in Nifty?
There are two primary ways through which you can invest in the Nifty index - via derivatives and mutual funds. Let’s take an in-depth look.
Investing in Nifty via Derivatives
Nifty derivative contracts such as futures and options use the index as an underlying asset. This essentially means that the price movement of the derivatives is linked to that of the index. However, since the index is not a stock, you cannot take delivery of the same on the expiry of its derivative contracts. Instead, all of the index derivatives will be mandatorily cash-settled at the end of the expiry.
With this concept explained, let’s delve a little deeper and try to understand how you can trade in Nifty through futures contracts and options contracts.
Investing in Nifty Through Futures Contracts
If you have either a bullish or a bearish view of the Nifty index, you can make use of the index futures contracts to profit off the price movements. For instance, let’s assume that Nifty is currently trading at 12,000 on November 01, 2021. You have a bullish view and therefore expect the index to rise to around 13,000 by the expiry.
All you need to do is purchase the Nifty NOV FUT contract at 12,000. If the index moves according to your expectations and touches 13,000 before the contract expires, you can simply square off your position.
Similarly, let’s now assume that you have a bearish view and therefore expect the index to fall to around 11,000 by the expiry. All you have to do in this case is short-sell the Nifty NOV FUT contract at 12,000. If the index moves according to your expectations and falls below 12,000 before the contract expires, you can simply square off your position and enjoy a profit.
Investing in Nifty Through Options Contracts
Just like futures, you can also use Nifty options contracts to profit off the price movements. Let’s use the same example as above. Assume that Nifty is currently trading at 12,000 on November 01, 2021. You have a bullish view and so you expect the index to rise to around 13,000 by expiry.
So, you purchase a call option contract of the index with a strike price of your choosing. To be more specific, you can purchase the Nifty Nov 13000 CE option contract since you expect the index to move up to around 13,000. Alternatively, you could also purchase the index call option contract with a strike price that’s lower than the current trading price of the index. However, you would have to shell out a higher premium for this, which can drive up your initial investment costs. Upon purchasing a call option contract, if the index moves up according to your expectations, all you have to do is square off your position.
Similarly, if you have a bearish view and expect the index to fall to around 11,000 by expiry, you should purchase a put option contract of the index with a strike price of your choice. To be more specific, you can purchase the Nifty Nov 11,000 PE option contract since you expect it to fall to around 11,000. When the index falls, you can simply square off your positions and enjoy a profit on your investment.
Investing in Nifty via mutual funds
Mutual funds like index funds feature the same portfolio of stocks that feature in an index like the Nifty. This effectively allows these funds to track the performance of an index, allowing the investors to take part in the value creation process afforded by the index. Unlike other mutual funds, index funds are more cost-effective, offer better diversification, and have a greater chance of providing investors with good returns. By investing in Nifty index funds, you would effectively invest in all the 50 components of the Nifty 50 index, thereby providing you with broad market exposure.
Conclusion
Although investing in Nifty derivatives is one of the best ways to trade, it is more of a short-term strategy. This is because the maximum amount of time that you can stay invested in a derivative contract is limited to 3 expiry months. Additionally, derivatives are also significantly riskier and require you to actively monitor the performance. If you’re looking for a long-term Nifty trading strategy with lower risk and little to no need for regular monitoring, investing in a Nifty index fund would be the best option.
