The ‘informational role of the options market in predicting the future price index in the underlying cash market in India’ is studied in this paper by applying the method of open interest and volume-based predictors (Bhuyan and Yan, 2002). Daily data for both price as well as non-price variables, for two different sub-periods have been employed to explore the above relationship and its changes (if any) in the subsequent period. The findings confirm that the open-interest-based predictors—for both the periods—are found to be significant in predicting the future price in the underlying cash market. But, as far as the volume-based predictors are concerned, it shows some mixed evidence. Though insignificant just after initiation, the volume-based predictors are found to be statistically significant in the later sub-period. Though both the predictors during the recent sub-period are significant at any conventional level of significance, the trading volume shows some more impact when compared to open interest in the matter of price prediction in the cash market. The significant increase in the value of adjusted R-square and F-statistics in the subsequent period also exhibits improvement in the informational role played by the Indian options market.

An option—a contract between two parties giving the taker (buyer) the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a predetermined date—is one of the important hedging instruments traded in derivative exchanges all over the world. It is well known that trading in options (as suggested by Black, 1975) may be more attractive than trading in underlying equity market due to the economic incentives provided by reducing transaction cost, capital requirements and trading restrictions, commonly seen in the equity market. The attractiveness of the options market can be proved by the increasing trend (Figure 1) in the total traded value in the options market over a period of time in a developing economy like India. Options can be used both for hedging as well as for speculation. If the assumptions (as suggested by Cao, 1999) relating to complete, competitive and frictionless markets are relaxed, the introduction of options contracts can affect the prices of underlying assets. It is well documented that not only the options prices, but also the non-price variables, such as ‘open interest’1, trading volume, etc., from the options market can affect the stock prices in the underlying equity market.