NISM-Series-VIII: Equity Derivatives · Understanding Index

Introduction to Stock Market Indices for NISM Equity Derivatives

Updated 11 October 2026 · Fact-checked

A stock market index is a number that tracks the combined price movement of a chosen basket of stocks. It works as a market barometer, a benchmark for portfolios, and the base for index funds, ETFs, index futures and index options. In exams, match each use to the right term.

Understand Introduction to Stock Market Indices

A stock market index is a single number that summarises how a group of shares is moving. Instead of watching hundreds of prices, you watch one figure. If the number rises, the stocks in the basket have, on the whole, gained in value. If it falls, they have, on the whole, lost value.

An index is called a market barometer because it shows the general mood and direction of the market, just as a barometer shows the weather. A broad index such as one covering large companies across sectors gives a view of the overall market. A sectoral index covers only one sector, such as banks or IT, and shows how that sector is doing.

The index is not a security. You cannot buy it directly. You can only trade products linked to it, such as index funds, exchange traded funds (ETFs), index futures and index options.

Indices have four main uses. First, they show market movement and sentiment. Second, they are a benchmark: a fund manager's return is compared with the index to judge performance. Third, they are the base for index funds and ETFs, which try to copy the index. Fourth, they are the underlying for index derivatives, used to hedge market risk, speculate on market direction and run arbitrage.

Index derivatives are important in this paper. An index cannot be delivered, so index futures and options in India are settled in cash. Understanding what the index represents helps you understand why the whole portfolio's market risk can be hedged with one contract.

Key formulas to remember

Index as a barometer: Index movement = combined movement of the stocks in the basket; It reflects the market or sector, not any single stock.
Uses of an index: Market barometer + Benchmark + Base for index funds/ETFs + Underlying for derivatives; Remember these four uses; options often list them as choices.
Index percentage change: % change = (Closing index − Previous index) ÷ Previous index × 100; Use this to compare index returns with portfolio returns.
Settlement of index derivatives: Index cannot be delivered → cash settlement; Index futures and options settle in cash.

How to solve Introduction to Stock Market Indices questions

Most questions on this topic ask you to identify what an index is, or to match a use to a situation. Use this method.

1Read the question and find the key word: barometer, benchmark, index fund, hedging, or underlying.
2Decide whether the question is about meaning, purpose or application.
3If it is about market direction or sentiment, think barometer.
4If it compares a portfolio or fund return, think benchmark.
5If it mentions copying an index, think index fund or ETF.
6If it mentions hedging, speculation or arbitrage on the market as a whole, think index derivatives.
7Eliminate options that treat the index as a tradable security or as a single stock.
8Check the remaining option for absolute words such as always or only, and avoid them.

Quickest way: Match the use to the keyword

When to use it: Use this for definition and application questions when time is short.

Spot the keyword in the stem.
Barometer = market direction. Benchmark = performance comparison. Index fund/ETF = replication. Derivatives = hedging, speculation, arbitrage, cash settlement.
Pick the option that matches and drop options that call the index a security you can buy directly.

Common mistakes in Introduction to Stock Market Indices

Thinking you can buy an index directly.
News reports say the index went up, so it feels like a product.
Fix: Remember an index is only a number. You trade it through index funds, ETFs, futures or options.
Treating an index as the price of one stock.
The index is quoted as a single figure.
Fix: Remember it summarises a whole basket of stocks.
Confusing benchmark with barometer.
Both words sound like measuring tools.
Fix: A barometer shows market direction. A benchmark is a yardstick to judge a fund or portfolio.
Assuming a sectoral index shows the whole market.
Any index is called a market index in casual talk.
Fix: Only a broad-based index reflects the overall market. A sectoral index reflects one sector.
Believing index derivatives are settled by delivering shares.
Stock derivatives are sometimes linked with delivery in the mind.
Fix: An index cannot be delivered, so index derivatives are cash settled.

Worked examples

Example 1

Which of the following is NOT a use of a stock market index? (A) Market barometer (B) Benchmark for fund performance (C) Underlying for index futures and options (D) Security that can be bought directly from the exchange like a share

Show the solution

List the four uses: barometer, benchmark, base for index funds/ETFs, underlying for derivatives.
Options A, B and C match these uses.
Option D says the index can be bought directly. An index is only a number, not a security.
So D is the option that is not a use.

Answer: (D)

Example 2

A fund manager's portfolio returned 12% in a year while the benchmark index returned 15%. What does this show?

Show the solution

A benchmark index is the yardstick to judge a portfolio.
Compare the portfolio return with the index return: 12% against 15%.
The difference is 15% − 12% = 3 percentage points.
The portfolio returned less than its benchmark.

Answer: The portfolio underperformed its benchmark by 3 percentage points.

Exam tips

Learn the four uses of an index as a list and match each to its keyword.
Watch for options that call an index a tradable security. They are wrong.
Remember index derivatives are cash settled because an index cannot be delivered.
Check whether the index in the question is broad-based or sectoral before choosing an answer.
Negative marking applies in this paper, so skip a question only if you cannot eliminate at least two options.

Practice questions from Understanding Index

Introduction to Stock Market Indices in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Introduction to Stock Market Indices: frequently asked questions

What is a stock market index?

It is a number that tracks the combined price movement of a selected basket of stocks. It shows whether the market or a sector is rising or falling. You cannot buy it directly.

Why is an index called a market barometer?

It shows the general direction and mood of the market, like a barometer shows weather. Investors read it to judge overall market trend.

How are indices used in equity derivatives?

They are the underlying for index futures and options. Traders use them to hedge market risk, speculate on direction and do arbitrage. These contracts are cash settled.

What is the difference between a benchmark and an index fund?

A benchmark is an index used to compare the return of a portfolio or fund. An index fund is a fund that tries to copy the index holdings and so earns close to the index return.