In this paper, we study the relevance of stock options open interest in conveying information about the future price movements in the underlying stocks. This investigation has been carried out by using daily closing data of 26 stocks in the National Stock Exchange (NSE) derivatives segment for the period May 2007 to October 2008. The result proves that stock options open interest does contain valuable information about future price movements in the underlying stocks.

Black (1975) suggested that informed traders might prefer trading in options market to stock markets because of the economic incentives arising out of lower transaction costs, less capital outflow, lower trading restrictions, limited loss potential, and higher leverage. Almost at the same time, Ross (1976) opined that options can improve market efficiency by permitting an expansion of the contingencies that are covered by traded securities. In the absence of complete markets, simple options are powerful abettors of efficiency in competitive equilibrium. The ever-increasing attractiveness of options market can very well be gauged from the total traded value in options market all over the world, and Indian options market is no exception to this (Mukherjee and Mishra, 2004).

This behavior of markets had always attracted the attention of researchers, and many researches were conducted to see if there were any relationships between options market and the underlying assets market. One line of thought was: Does trading in options market provide information about future price movements in the underlying assets?

If, as suggested by Ross (1976), options help to complete the market, agents with information about future contingencies should be able to trade more effectively on their information (Roll et al., 2007) and lead others to discover that information. Thus, options not only may lead the underlying assets in impounding information but also may provide information that simply cannot be inferred from the underlying assets markets (Bhuyan and Chaudhury, 2001). Similarly, if the assumptions relating to complete, competitive, and frictionless markets (Cao, 1999) are relaxed, introduction of option contracts can affect the prices of underlying assets (Mukherjee and Mishra, 2004). Therefore, if traders, with relevant information, choose to trade in the options market, not only the option prices and options market activity will become relevant in impounding the information and its subsequent discovery, options could in fact lead the underlying assets in terms of price change and trading activity.

Applied Finance Journal, Indian Equity Options Market, National Stock Exchange, Future Price Movements, Frictionless Markets, Indian Options Market, Decision Making, Information Collection, Options Transactions, Options Trading Strategies, Financial Markets.