New Insights into the Impact of Futures and Options Trading on the Underlying Spot Market Volatility in India

G. Saravanan1, Gayathri Devi R.2 and Malabika Deo3

Department of Commerce,Pondicherry University, Kalapet, Puducherry 605014, India

1E-mail: gsara_1983@yahoo.co.in, 2E-mail: gayu_devipearl@yahoo.co.in, 3E-mail: deo.malabika@yahoo.co.in

Abstract

Indian capital market saw the launching of index futures and options on NSE on June 12, 2000 and June 4, 2001 respectively.This launching of futures and options in Indian stock markets was perceived to increase volatility in the stock market by some researchers, while other researchers anticipated decline in volatility. So far, studies have examined volatility implication in macro-level, that is, they measured volatility reduction by comparing volatility of pre and post derivatives period, using various models.  This paper tries to study in micro-level,  how as to the volatility implications are there across the days of the week in post futures and options period in Indian stock market by isolating volatility related to market-wide factors as well as international-wide factors. This paper also examines the nature of the volatility after the introduction of futures and options contracts. The study has been undertaken with a comprehensive daily data set of S&P CNX Nifty, Nifty Junior and S&P 500 index from October 4, 1995 to May 31, 2007, and to measure the volatility GARCH (1, 1) model has been used. The results of the study show that the presences of derivatives markets on S&P CNX Nifty have declined the volatility marginally and volatility implication in days of the week as a consequence of derivatives introduction revealed the presence of speculative activities in spot as well as derivatives market. And, further results show that options market reduce volatility and stabilize underlying spot market marginally more than futures market.

Keywords:  Futures, Options, Volatility, Heteroskedasticity, GARCH