Advantages of Nifty Futures: Understanding Index Derivatives Trading

Fundamentals of Index Futures

The Nifty Futures represents a particularly distinctive instrument within the Indian derivative market. It ranks as the most actively traded and liquid amongst all futures contracts and even features amongst the top ten index futures contracts globally.

When you become comfortable with trading futures, you will likely monitor this contract particularly closely. Therefore, before proceeding further, please take a few moments to review knowledge about the Index which we previously discussed.

Assuming you possess a grasp on index fundamentals, I’ll proceed to discussing Nifty Futures or Index Futures.

We understand that futures instruments derive their value from underlying assets. Regarding Nifty Futures, this would be movements of the Index itself. Thus, when the Nifty Index appreciates in value, its futures follow suit. Conversely, an Index decline will cause futures depreciation as well.

Here is the snapshot of a Nifty Futures Contract:

Nifty Futures are available in three different variants: current month, mid-month, and far month. These have been distinguished by highlighting them. At the moment of capturing this snapshot, the Nifty Futures rate per unit stood at ₹18,275 whilst the spot index value registered ₹18,255. This disparity between both prices is explained by futures pricing mathematics, which will be thoroughly discussed in the following chapter.

Further, if you notice the lot size here equals 50 units. We know the contract value is:

CV = Futures Price × Lot Size

= 18,275 × 50

= ₹9,13,750

These are the margin requirements for trading Nifty Futures.

This overview of Nifty Futures should have provided you with fundamental concepts. Its liquidity constitutes one of numerous reasons why it enjoys such popularity, so let us proceed to examining what this means and how it can be determined.

Understanding Impact Cost

The National Stock Exchange (NSE) defines Impact Cost as the expense that must be absorbed by either a buyer or seller when completing a transaction for a particular security. This metric assesses market liquidity and provides a more accurate evaluation of trading costs than the bid-ask spread. Additionally, it is measured separately for buyers and sellers and varies according to transaction size. Impact Cost remains volatile and keeps changing based on the order book. Certain indices such as Nifty 50 or Nifty 500 have an Impact Cost threshold requirement for inclusion eligibility—further details can be found in the respective Index Methodology documents.

The formula for ascertaining impact cost is:

Ideal Price = (Best Buy Price in Orderbook + Best Sell Price in Orderbook) ÷ 2

Actual Buy Price = Sum of (Quantity × Execution Price) ÷ Total Quantity

Impact Cost (for that particular quantity) = (Actual Buy Price – Ideal Price) ÷ Ideal Price × 100

To explain this using an example, let us consider Reliance Industries:

Suppose a person wants to purchase 280 quantities of Reliance Industries. Now let us calculate the impact cost for this transaction:

Order Book Snapshot:

Best Buy Price: ₹2,847.60

Best Sell Price: ₹2,847.80

Available at ₹2,847.80: 25 shares

Available at ₹2,848.15: 255 shares

Calculation:

Ideal Price = (2,847.60 + 2,847.80) ÷ 2 = 2,847.70

Actual Buy Price = [(25 × 2,847.80) + (255 × 2,848.15)] ÷ 280 = 2,848.118 ~ ₹2,848.12

Impact Cost for buying 280 shares = [(2,848.12 – 2,847.70) ÷ 2,847.70] × 100 = 0.015%

Key Takeaways on Liquidity and Impact Cost

The few critical messages that you should retain from this discussion are:

Impact cost provides a sense of liquidity levels

The higher the liquidity in a security, the lesser the impact cost

The spread between buying and selling prices also indicates liquidity

Higher the spread, the higher the impact cost

Lower the spread, the lower the impact cost

Higher the liquidity, lesser the volatility

If the security lacks liquidity, placing market orders proves inadvisable

Benefits of Trading Nifty Futures

Understanding impact cost becomes particularly relevant when trading Nifty Futures because this instrument offers exceptionally tight spreads and minimal impact costs compared to individual stock futures. This superior liquidity translates to several practical advantages:

Cost Efficiency: Lower impact costs mean traders retain more of their profits and lose less to transaction inefficiencies.

Better Price Execution: High liquidity ensures orders execute at prices very close to quoted rates, minimising slippage.

Flexibility: The ability to enter and exit positions rapidly without significantly affecting prices provides strategic flexibility unavailable in less liquid instruments.

Reduced Volatility Risk: Greater liquidity generally correlates with lower volatility, making position management more predictable and less prone to erratic price movements.

These characteristics make Nifty Futures an attractive instrument for both short-term traders seeking quick profits and longer-term participants managing portfolio exposure to broader market movements. Understanding these liquidity dynamics proves essential for successful futures trading outcomes.