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Tuesday 21 August 2007

Selecting the right index

In selecting the index and contract month one should consider the following points.

Expiration date: If the investor has a month or two’s view about the market then he should choose that index futures which has a similar time left for expiry.

Liquidity: The index and the contract month, which is the most liquid must be used. This will save cost because of the low bid-ask spread. This also saves hedging costs.

Stock should be correlated to the index: The stock to be hedged should have a correlation with the index selected.

Potential mispricing: One should sell index futures contract which is overpriced. In such an event one can not only hedge but also earn some profit in selling high.

In a nutshell, one should hedge by using the most popular and fairly priced index and delivery month should not be very far since liquidity and predictability of very few contracts are low.

For Stock advice : Saturday watch on Market Outlook