NISM VIII — Equity Derivatives ~5 min read

Stock Indices — Types and Construction

A stock index is a statistical indicator of the price movement of a basket of stocks — a proxy for overall market or sector performance. Indices are built using...

Definition

Indices and Weighting Methods

A stock index is a statistical indicator of the price movement of a basket of stocks — a proxy for overall market or sector performance. Indices are built using one of four methodologies: market-cap weighted, free-float market-cap weighted, price weighted or equal weighted.

In Simple Words

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A market-capitalisation index weights each stock by total market cap (price × total shares). A free-float index — now the global standard — weights by the market cap of only the shares freely tradeable (excludes promoter, cross-holding, locked-in). A price-weighted index (Dow Jones) sums stock prices and divides by a divisor; a ₹100 stock has 2× the influence of a ₹50 stock. An equal-weighted index gives every constituent identical weight. India's Sensex and Nifty moved to free-float many years ago so that promoter holdings don't distort the index.

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Index = Basket

A weighted basket of stocks representing a market slice

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Market Cap Weight

Big companies swing the index more — Reliance > small-cap

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Free-Float

Only "tradeable" shares count — locked-in promoter stakes don't

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Equal Weight

1% to every stock — the micro-cap gets the same weight as TCS

Real-Life Scenario

A Practical Example

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Five

Real-Life Scenario

Five-stock index starts at base 100 on 1 Jan 1995. Prices on that day: AZ ₹150, BY ₹300, CX ₹450, DW ₹100, EU ₹250 with share counts (lakhs) 20, 12, 16, 30, 8 → total m-cap ₹18,800 Cr. Today's prices: 650, 450, 600, 350, 500 → new m-cap ₹42,500 Cr. Index today = (42,500 / 18,800) × 100 = 226.06 — index rose 126%. By contrast a price-weighted version would be (150+300+450+100+250)/5 = 250 vs (650+450+600+350+500)/5 = 510 → 104% gain. Same stocks, different methodology, different return — exactly why choice of index methodology matters for derivative pricing.

Key Points to Remember

What Makes This Important

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Market-cap weighted — weight ∝ (price × total shares)

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Free-float weighted — weight ∝ (price × freely tradeable shares) — current global standard

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Price weighted — weight ∝ price only (Dow Jones style)

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Equal weighted — every constituent has the same weight

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Sensex, Nifty and SX40 all use the free-float market-cap method

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Methodology choice materially changes calculated returns

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Free-float gives a truer picture of investable market performance

The Formula

Free-Float Market-Cap Index

Free-Float Index = (Current Free-Float M-Cap / Base Free-Float M-Cap) × Base Index Value

Free-Float M-Cap — Sum across constituents of (price × free-float shares)

Base M-Cap — Free-float market cap on the index base date

Base Index Value — The number assigned on the base date (e.g., 100 for Nifty on 3-Nov-1995)

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Why free-float: promoter stakes that never trade shouldn't drive the index. Removing them makes the index reflect returns actually achievable by institutional and retail investors.

FAQs

Frequently Asked Questions

Nifty 50 has a base date of 3 November 1995 and a base index value of 1,000. All Nifty values are calculated as a ratio of current free-float market cap to the base-date free-float market cap, multiplied by 1,000.

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