The aim of this paper is to examine the impact of derivatives trading and cash market volatility in the Indian context. The volatility is examined considering the day-of-the week effect, domestic market factors and world market movements using GARCH models. The change in volatility and information efficiency is examined for pre and post derivatives period. The analysis shows that the introduction of index futures and options has reduced spot market volatility. Persistence of volatility is reduced in post-derivatives period and day-of-the-week effect is found to be insignificant after the introduction of derivatives. The results provide evidence of increased market efficiency in the Indian stock market after the introduction of derivatives.

The study shows that both S&P CNX futures and option contracts have a stabilizing effect on the underlying stock market and supports the "market completion" hypothesis and rejects the "destabilizing forces hypothesis". The introduction of derivatives trading world over has intensified the debate on the economic and social impact of futures and options trading. Stock market derivatives first appeared in the US in the early 1980s and quickly spread to the major financial centers of Europe and the Pacific Rim. In the late nineties, many emerging and transition economies have introduced derivative contracts successfully.

The trading volume of stock market derivatives often exceeds the trading volume of underlying stocks. The introduction of derivatives in emerging and transition economies raised interesting issues unique to these markets. Emerging stock markets operate in very different economic, political, technological and social environments than markets in developed countries like the USA or the UK. Hence, it is pertinent to study the volatility dynamics in developing countries. Moreover, determining the reason for any change in volatility is of vital significance for derivatives market regulators. Derivatives play a very important role in the price discovery process and risk management. It is widely used by mutual funds and institutional investors for risk management purposes.