Price-based index

Two indices can hold the same things and still behave differently, depending on what makes their weights move.

A price-based index fixes its weights and leaves them alone. Once the exchange sets them, the index captures only price movements. A commodity's weight does not change because its price changed.

The workbook is explicit: commodity indices are price-based indices and not volume-based indices.

Equity indices work the other way. They are volume-based, where the weights of the underlying securities keep changing daily depending on market capitalisation. The workbook's own illustration is Reliance Industries, whose weight may move to 8% or 12% because of its price movement, since its market cap rises with the price.

In a commodity index that does not happen. Gold's weight in MCX BULLDEX stays at around 60% every day, because it was fixed at 60% for the year.

Weights change only when the index is rebalanced, and that happens at least once a year.

The rule. Commodity indices are price-based and not volume-based. Once the weights of the commodities in the index are determined, the index captures only price movements. The weights remain the same unless they are reviewed for rebalancing before the end of 12 months, because a commodity has exited the current basket.

The contrast the workbook draws. Equity indices are volume-based, where the weights of the underlying securities also keep changing daily depending on market capitalisation. Reliance Industries' weight may move to 8% or 12% purely because its price moved, since its market cap moves with its price. In a commodity index, Gold's weight in MCX BULLDEX will continue to be around 60% daily, as its weight is kept constant at 60% during 2025.

What fixed weights buy you. The workbook draws one consequence straight from this property: to some extent commodity-based indices may be a proxy of inflation in certain sectors. If MCX iCOMDEX Base Metal goes up by 10% over one year, somewhere it indicates that inflation in the metals family comprising the index is nearly 10% — subject to adjustments of total return such as cost of carry on futures. That reading only works because the weights did not drift. An index whose weights moved with value would be measuring two things at once.

How the weights get set, and when they change. They come from scoring each commodity on production value and liquidity value, in a ratio of 25:75 with neither factor below 25%. Once set they stay fixed for a year, unless rebalancing is needed because trading in a constituent's derivatives has stopped for regulatory or other reasons. Weights and constituents must be reviewed and rebalanced at least once a year — NCDEX and MCX both use the calendar year, January to December — and a proposed rebalanced index must be disclosed at least three months before the date of publication on the new weights. Rebalancing can also be forced in extraordinary situations such as a ban or suspension of trading in a constituent's futures. When it happens, the index value is not reset to its base value; only the constituents and their weights change.

Caps on the fixed weights. In a composite index each constituent gets a minimum of 1% and a maximum of 30% under SEBI's rule, with exchanges free to work inside that — MCX iCOMDEX uses 2% to 30% with a sectoral-level cap of 40%. In a sectoral index there is no such cap.

What feeds the level. The index value is disclosed on the traded price in the constituent's near-month contract, and trades generated via spread trades are ignored for index computation, because one leg of such a trade depends on the other rather than reflecting an independent view.

Take a two-commodity bullion basket at BULLDEX's rounded 2025 weights — gold 60%, silver 40% — with the index at 1,000.

Year one. Gold rises 25%; silver falls 5%.

The index closes the year at 1,130.

Now the interesting part, which is year two. Start the year from Rs 600 of gold and Rs 400 of silver per Rs 1,000 of index value. After year one those holdings are worth Rs 750 and Rs 380. A volume-based index would carry the drifted weights forward — gold 66.4%, silver 33.6%. A price-based index does not; at rebalancing the weights are re-derived from production and liquidity scores, and say they come out at gold 58%, silver 42%.

Year two. Gold falls 10%; silver rises 20%.

Same two prices, same two metals, and a 2.5 percentage point difference in the index's return — entirely from how the weights were set.

Price it. An index future has a lot of 500 units, so at an index of 1,130 one lot is worth 1,130 x 500 = Rs 5,65,000. Across 6 lots, that 2.5 percentage point difference is about 28.5 index points:

28.5 x 500 x 6 = Rs 85,500

And this is exactly why the inflation reading needs fixed weights. A price-based index that returns 2.60% is telling you something about bullion prices. A drifting index that returns 0.08% on the same prices is telling you something about last year's returns as well.

Chapter 2 (Commodity Indices), section 2.3, point 4 of the index construction and maintenance rules.

Expect the direct contrast as a fill-in-the-blank: commodity indices are ____ based indices while equity indices are ____ based indices — price and volume. The workbook's two illustrations are the ones to have ready: Gold at around 60% in BULLDEX, and Reliance at 8% or 12% in an equity index. Expect also the consequence it draws — that a commodity index can serve as a rough sectoral inflation proxy, with its cost-of-carry caveat — because that inference depends entirely on the weights being fixed.

• Price-based means the weights are fixed and only prices move the index. It does not mean the index is a simple average of prices.
• Commodity indices are price-based; equity indices are volume-based. Reversing the two labels is the single commonest error on this point.
• Weights change only on rebalancing. That is at least once a year, and sooner if a constituent's derivatives stop trading for regulatory or other reasons.
• Rebalancing does not reset the index to its base value. Only the constituents and their weights change; the level continues from where it was.
• A rebalance needs three months' prior disclosure before publication on the new weights.
• Gold's 60% in BULLDEX is a 2025 figure, fixed for that year. It is not a permanent property of the index, and the 2024 figure was 59.425496%.
• The inflation reading still carries a caveat — subject to adjustments of total return such as cost of carry on futures. Fixed weights make the reading possible; they do not make it exact.
• Spread trades are excluded from index computation and the level comes from the near-month traded price. Neither fact has anything to do with whether the index is price-based, and they are easy to mix in.