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Besides arresting volatility and improving efficiency,
the introduction of derivative contracts in India is aimed
at enhancing the trading volume of stock markets. In view
of the above, this paper is designed to investigate the
impact of equity derivatives on the trading volume of underlying
Indian stock market. For this purpose, the daily traded
value data of cash market and 22 individual stocks were
collected and analyzed by using before-and-after control
sample technique. The results of the study show that Compound
Annual Growth Rate (CAGR) of trading volume has declined
slightly after the introduction of derivatives. However,
the study found a positive impact of expiration of derivatives
on trading volume of sample stocks.
Derivatives trading is an integral part of the maturing
process of capital market of every nation. Derivative contracts
were introduced just as a risk management tool in the financial
market. However, they can be used for price risk as well
as to speculate thereby attracting hedgers and speculators
towards the market. Therefore, derivatives act as a double
edged weapon. Due to the availability of derivative instruments
in the market, there may be a shift in the quality of underlying
spot market transactions like changed volatility structure,
improved market efficiency, etc. Consequently, there should
be some impact of derivative instruments on the trading
volume of underlying stocks and the whole of the market.
Two bodies of theory exist in literature relating to the
impact of equity derivatives on the trading volume of underlying
spot market. Supporters of first theory argue that when
derivative contracts are available in the market, speculators
shift from cash segment to derivatives segment resulting
in the reduction of trading volume of cash market (Bandivadekar
and Ghosh, 2004). The second theory is based on the fact
that derivatives attract more traders towards the market
as they have the option of risk hedging with the availability
of derivatives contracts in the market. Consequently, it
should increase the trading volume of cash market (Hayes
and Tennenbaum, 1979; and Branch and Finnerty, 1981). To
have an empirical view, most of the academicians and researchers
documented this effect in developed markets and concluded
a significant increase in the trading volume due to introduction
of derivatives there. Among the authors who have found the
positive impact on trading volume of stock market include
Hayes and Tennenbaum (1979); Branch and Finnerty (1981);
Skinner (1989); Rao et al. (1991); Jegadeesh and Subrahmanyam
(1993); Long D Michael et al. (1994); Gjerde and Saetem
(1995); Chaudhury and Said Elfakhani (1997); Peat and Micahael
(1997); Wei et al. (1997); Kumar et al. (1995); Corredor
et al. (2001); and Chien (2002). However, the study of Kim
and Oliver (2000) found a reduction in trading volume of
the underlying securities on the Hong Kong Stock Exchange
due to an initial options listing. Similarly, the study
of Kumar et al. (2003) indicated a reduction in trading
volume of underlying stocks due to options listing while
analyzing the data relating to Indian stock market.
Further, some studies have tried to find out the expiration
day effect of equity derivatives on trading volume of underlying
assets. To quote a few, Schlag (1996); Corredor et al. (2001);
and Hagelin and Peralkeback (2004) examined the impact of
expiration day of index futures and options on the trading
volume of underlying markets and indicated that trading
volumes on the cash market were significantly higher on
expiration days than on other days. However, the study of
Chow et al. (2003) found no evidence of abnormal trading
volume on the expiration day of Hang Sang Index (HSI) derivatives
on the underlying cash market in Hong Kong.
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