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The IUP Journal of Derivatives Markets:
An Analysis of the Cross-sectional Impact of Option Trading Volume, Strike Price and Premium of Options on the Volatility of Underlying Stock Prices
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Trading in derivatives has recently been introduced in India. Market regulators find that volatility in the Indian market is much higher than in the developed market. Higher volatility induces investors to buy call options since they are willing to pay higher premiums. This paper is an attempt to determine the causes of volatility for which the implied volatility (calculated using Black-Scholes model) of call options of a sample of the largest traded option stocks in India is examined. The volume of options traded, strike price, option premium and stock price in various combinations are used as variables in this analysis. The investigation yields mixed results, i.e., in certain cases, the mean volatility of in-the-money call options is higher than that of out-of-the-money call options whereas, in other cases, opposite results are observed. Regression analysis finds that the volume of traded option has a significant negative relationship on the implied volatility. The ratio of strike price plus premium to stock price is also found to be negatively related to implied volatility. It is also found that, in some cases, a positive relationship exists between these two variables on implied volatility. The results are similar to the findings of Rubenstein. The reasons for the contradictory results are not clear but could perhaps be due to the fluidity of the general political and economic condition prevailing in India during the period under study. This may have been the causative factor of asymmetric behavior on the part of the investors. However, it is found that the premium - volume differential of the call options is positively related to the volatility of all the sample stocks.

Derivative trading has recently been introduced in the Indian capital market. The procedural and regulatory norms for the market are being evolved. In the recent past, the regulatory authority in India set up a research group for the purpose of advising the authority on derivative trading. The group, called JRV group, observed that volatility in the Indian market is quite high as compared to developed markets, and volatilities are not constant but vary over time. The group also suggested a margin fixation methodology and an initial methodology for volatility estimate via an exponential moving average method. In a nascent market, which is in a developing stage, the sources of high volatility are not precisely known, perhaps because of interplay of several economic variables on the stock price.

 
 
 

An Analysis of the Cross-sectional Impact of Option Trading Volume, Strike Price, Stock Prices, derivatives, Market regulators, volatility, investors, higher premiums, Black-Scholes model, variables, investigation yields, mixed results, mean volatility,money call,out-of-the-money.