RESEARCH

Significance of Non-Price Variables in

includes research articles that
focus on the analysis and
resolution of managerial and
Price Discovery: An Empirical Study
academic issues based on
analytical and empirical or of Stock Option Market in India
case research

Sandeep Srivastava, Surendra S Yadav, and P K Jain

Executive The efficiency of the financial markets is important as it ensures increased productive effi-

Summary ciency and economic growth through better capital allocation. Price discovery is the central
aspect of financial markets. The relatively efficient price signals also facilitate the participa-
tion of uninformed investors to make suitable portfolio choices. Derivative instruments like
option contracts enhance informational efficiency of the underlying’s market through better
price discovery as these securities are expected to increase the flow of information in the
market. Besides, they facilitate hedging of risk. In India, exchange-trade derivates are of re-
cent origin in the stock market.
This study investigates the significance of net open interest and trading volume in stock
option and stock index option market to predict the underlying stock prices/index level. In
the study, only 15 stock option contracts (having maturity of one-month) and Nifty options
for the entire period, i.e., November 10, 2001 to November 2, 2004, have been analysed. The
analysis could not be carried out for all the stocks in option segment because of the fact that
the options were not traded or the trading range and volumes were too thin to justify any
analysis.
The major findings of the study are as follows:
• Net open interest of stock option is one of the significant variables in the determination of
the future spot price of the underlying stock.
• Open interest-based predictors are statistically more significant than the volume-based
predictors in the Indian context too as is the case for the US market.
• The trading behaviour of Indian investors is found to be different from their counterparts
in the developed world. This difference can be attributed to:

KEY WORDS (i) the nascent state of derivatives market in India

(ii) extremely limited participation of institutional investors in the Indian stock derivative
Option Market market because of regulatory restrictions; as such investors are allowed to use deriva-
Trading Volume tive securities mainly for hedging and arbitrage purposes only.
The findings would definitely help the regulatory bodies in policy-making and further
Stock Option
strengthening the efforts to promote the derivative market in India. There are many areas
Price Discovery which are still unexplored and can be addressed by the future studies by using the intraday
Open Interest data and a larger sample for the stock options.

VIKALPA • VOLUME 33 • NO 2 • APRIL – JUNE 2008 15

P
rice discovery is the central aspect of financial complements the efforts of Bhuyan and Chaudhury
markets. The relatively efficient price signals that (2001) and Bhuyan and Yan (2002), and provides sup-
prevail in the marketplace are important for en- port for their hypothesis in the Indian context. Finally,
hancing productive efficiency and economic growth the evidence also expands our knowledge of informa-
through superior capital allocation. These signals also tional role of open interest and trading volume in stock
facilitate the ability of relatively uninformed investors option market.
to make suitable portfolio choices. As illustrated in
Grossman (1988), derivative securities enhance price LITERATURE SURVEY
discovery by pricing a static payoff pattern that repre- Extending the argument of Black and Scholes (1973) and
sents the value of an otherwise dynamic investment Black (1975), Manaster and Rendleman (1982) contend
strategy. Other literature also documents the evidence that option market plays an important role as a trading
of increased informational efficiency consequent upon vehicle that provides high liquidity, low trading costs,
the introduction of derivatives. They are expected to leverage, and least restrictions (uptick’ rule for short
increase the flow of information into the market result- sales). Bhattacharya (1987) adds upper bound on the loss
ing in better price discovery of the underlying asset. if long in the option, as another factor that makes in-
Over the past three decades, option contract – de- formed investors prefer option market. Complement-
fined as a contract that gives the holder (known as op- ing these results, Cassano (2001) concludes that the
tion buyer) the right to buy or sell an underlying asset existence of option contracts reduces the gap between
in future at a pre-agreed price – has been widely accepted incomplete and complete markets to negligible. Extend-
as one of the most useful derivative securities. Accord- ing the model of continuous insider trading given by
ing to Mayhew (2000), options and futures reduce the Kyle (1985) to demonstrate the role of options, Back
transaction cost associated with taking a position in the (1993) concludes that option is not redundant when it is
market. Therefore, these securities are expected to in- actually traded. The existence of option market affects
crease the flow of information resulting in better price the prices of underlying assets and thus enhances the
discovery. While valuing option contracts, Black and flow of information. Further, he contends that the vola-
Scholes (1973), in their seminal work, assume these se- tility of underlying assets becomes stochastic when the
curities as redundant assets and value them with a no- option is traded on such assets. Cao (1999) concludes
arbitrage relation. They assume that a portfolio that when the assumptions relating to complete, com-
comprising stocks and (riskless) bonds would replicate petitive, and frictionless markets are relaxed, introduc-
the option position. Does it mean that option contracts tion of option contracts affect the prices of underlying
are redundant securities? Not really.. Grossman (1988) assets. All these studies support the argument that price
argues against the notion that a real security is redun- of stock options may reflect additional information not
dant when it can be synthesized by a dynamic trading captured by the observed stock prices resulting in a bet-
strategy. He observes that such notion essentially ignores ter price discovery.
the informational role of real securities markets. Several Notably, the volume of trading witnessed in the op-
research studies have been conducted to examine the tion and stock market has also been found relevant in
role of option market and its contribution in improving understanding the price discovery function. Blume,
the quality of underlying asset market. The literature Easley and O’Hara (1994) contend that volume provides
survey presented in the next section documents this evi- information about the quality of trader’s information,
dence. which cannot be deduced from the price statistic. They
In India, exchange-traded derivatives are of recent investigate the role of volume and trade information in
origin in the stock market. Trading in stock index op- Brown and Jennings Model (1989) and Grundy and
tions and stock options started in the year 2001. Cur- McNichols Model (1989), and suggest the changes that
rently, there are 4 indices and 118 stocks that are traded need to be brought about in these models. They support
in the option segment on the National Stock Exchange. complementarity in price and volume information and
This paper seeks to examine the informational efficiency conclude that a trader who ignores volume would face
of option trading volume and open interest in predict- penalty because the price impounds information about
ing underlying stock prices in the Indian context. It also the average level of trader’s private information while

16 SIGNIFICANCE OF NON-PRICE VARIABLES IN PRICE DISCOVERY

volume captures signals relating to the quality of trad- attempts to document the impact of non-price variables
er’s information. Extending this study to establish the of stock option market on the underlying stocks in the
inter-linkage between option and stock market, Easley, Indian context with a longer sample period.
O’Hara and Srinivas (1998) argue against the widespread
belief that price in option market is unilaterally derived DATA AND METHODOLOGY
from the underlying stock prices. They develop a model The data for this study was taken from the daily
using the technique of causality testing proposed by bhavcopy posted on the NSE website. It provides all the
Granger (1969) and Granger and Newbold (1977) to in- market information on call and put options traded on
vestigate the relationship between the option volume different stocks during the day that include option pre-
and stock price changes to assess the informational con- mium (open, high, low, and close), trading volume, and
tent of option market and information lead-lag between open interest at each strike price. Currently, we have
cash and option market. The conclusions drawn from stock option contracts available in the Indian market for
this study are two fold: (1) stock prices lead option vol- one-, two- and three- month maturity. As the present
umes; and (2) option volumes lead stock price changes. study attempts to decipher the price-volume relation-
The first conclusion is in line with the hedging argu- ship, the liquidity of stock options becomes an impor-
ment while the second indicates that option market is tant issue. Keeping this in view, we have included one-
an important venue for information-based trading. They month contracts only because they are most liquid. Fur-
propose the asymmetric information-based theory ther, the expiration day data has been excluded from
where the informed traders would trade in call and put the study to avoid bias due to expiration effect.
options based on their private information which would While examining the informational efficiency of op-
convey useful signals to the other market participants tion market, the analysis could not be carried out for all
resulting in an impact (positive or negative) on the price the stocks in option segment because of the fact that the
of underlying stock. This is probably the first study that options were not traded or the trading range and vol-
presents significant evidence of impact of option vol- umes were too thin to justify any analysis. The option
umes on stock prices. data was available for only 12 stocks for the entire pe-
Bhuyan and Chaudhury (2001) examine the role of riod, i.e., November 10, 2001 to November 2, 2004. The
option market’s open interest to capture information model for examining informational content requires the
about the future movement of underlying stock and data regarding trading volume and open interest at dif-
show that the trading strategies based on this predictor ferent strike prices. In case a particular stock option does
yields better results as compared to the buy-and-hold not trade on the stock exchange, such data cannot be
and passive covered call strategies. Further, Bhuyan and obtained. Therefore, 3 more stocks were included for
Yan (2002) develop several price predictors from the studying the informational content as the open interest
open interests and trading volumes of individual stocks and trading volume data at different strike prices were
from the option market and conclude that these factors available for more than half of the period specified above.
exhibit significant explanatory and predictive power for The list of sample firms is given in Table 1.
the future stock prices. The encouraging results provided This study investigates the significance of net open
by this study are one of the driving forces for the present interest and trading volume in stock option and stock
initiative. index option market to predict the underlying stock
There is a general agreement with the basic premise prices/index level. The methodology used here has been
drawn by Bhuyan and Chaudhury (2001) and Bhuyan adapted from Bhuyan and Chaudhury (2001), Bhuyan
and Yan (2002) that as against the total volume consid- and Yan (2002), and later replicated in the Indian con-
ered by Easley, O’Hara and Srinivas (1998), net open text by Srivastava (2003). The notations used are the same
interest of call options and put options together should as have been used in these studies.
provide a better indication of the future stock price A stock is assumed with a set of call and put options
movement. Srivastava (2003) examines the informational maturing at T, the current time being T0. The stock price
role of stock option market in India using this approach. at time t would be St and XCi and XPi are the set of strike
However, it was conducted for a small period, i.e., four prices for call and put options respectively such that XCi,
months. The present study is among one of the earlier i = 1,2,……, k; XPi, i = 1,2,……, m and t ∈ [T0, T]. Let OCit

VIKALPA • VOLUME 33 • NO 2 • APRIL – JUNE 2008 17

Table 1: Sample Firms k
Vt C = ∑ qitC X iC (5)
i =1
No. Underlying Stock
VitC
1. Associated Cement Company Ltd. qitC = k
2. Bharat Petroleum Corporation Ltd. ∑V C
it
(6)
i =1
3. Gujarat Ambuja Cement Ltd.
4. Hindustan Lever Ltd. m
Vt P = ∑ qitP X iP (7)
5. Hindustan Petroleum Corporation Ltd. i =1
6. Infosys Technologies Ltd.
7. Mahanagar Telephone Nigam Ltd. VitP
qitP = m
8. Mahindra & Mahindra Ltd.
∑V it
P (8)
9. Reliance Industries Ltd. i =1

10. Satyam Computer Services Ltd.

where qCit is the weight of call options with exercise
11. State Bank of India
price, XCi, and qPit is the weight of put options with exer-
12. Tata Engineering and Locomotive Co. Ltd. (Renamed As
Tata Motors Ltd.) cise price, XPi, for non-zero volume.
13. Tata Iron and Steel Company Ltd. Based on the two open interest based predictors and
14. Tata Power Ltd. two volume-based predictors, the following regression
15. Tata Tea Ltd. model is used to see relative significance of each of these
predictors:
and OPit be the net open interest for a call and put option log ST = α0 + α1 log (T-t) + α2 log St + α3 log OCt +
with the strike prices of XCi and XPi respectively. α log OP + α log VC + α log VP + ε (9)
4 t 5 t 6 t t
The call option open interest-based predictor (COP)
is defined by: where ST is stock price at maturity, T-t is time to ma-
turity, St is stock price at time ‘t,’ OCt, and OPt are call
k
OtC = ∑ witC X iC and put option open interest-based predictors, and VCt
(1)
i =1 and VPt are call and put option volume-based predic-
tors.
OitC
witC = k In case the call option-based predictor has positive
∑O C (2)
it coefficient and put-option based predictor has negative
i =1
coefficient, it would support the hypothesis that in-
where, OCt is COP at time t, k is the number of differ- formed investors prefer to deal in option market as
ent call options having non-zero open interests, wCit is against the cash segment. Hence, the information is re-
the weight of call options with strike of XCi. Similarly, flected first in the option segment and then gets trans-
put option open interest-based predictor (POP) is de- ferred to the cash market.
fined as:
m
FINDINGS AND ANALYSIS
O = ∑w X
P P P
(3)
t
i =1
it i
This section covers the analysis of call and put option
open interest and volume-based predictors for Nifty in-
OitP dex and individual stocks. This study covers the data
witP = m

∑O P
it
(4) for 15 most liquid options on individual stocks traded
i =1 at NSE. The regression analysis has been carried out for
all the 15 stocks separately. The data for expiration day
where, OPt is POP at time t, m is the number of differ- has been excluded from the study that resulted in a to-
ent put options having non-zero open interests, wPit is tal of 714 days for which analysis has been conducted.
the weight of put options with strike of XPi. The results are quite encouraging and are summa-
Similarly, volume-based predictors for both call op- rized in Table 2 for open interest-based predictors while
tions, VCt, and put options, VPt, are defined as follows: the detailed results are given in Table 3. Out of the total
15 stock options covered in this study, 10 are found to

18 SIGNIFICANCE OF NON-PRICE VARIABLES IN PRICE DISCOVERY

have positive coefficients for COP and negative coeffi- model could explain more than 70 per cent of the varia-
cients for POP. They are statistically significant at 99 per tions in spot price of these underlying stocks.
cent confidence interval for both COP and POP except The explanatory power of the model may be consid-
for M&M and MTNL. In these two stocks, POP is statis- ered good in the light of the above-mentioned statistics.
tically significant at 95 per cent confidence interval for The reverse phenomenon is observed in respect of two
M&M and not statistically significant for MTNL. Also, stocks namely, Tata Motors and Tata Tea. The stocks
the adjusted R2 for all these stock options is quite high have negative coefficients for COP and positive coeffi-
that reflects the considerable explanatory power of the cients for POP and the results are statistically signifi-
model in these cases. Except for BPCL, M&M, and Tata cant at 99 per cent confidence interval. Further, the
Tea, the adjusted R2 is higher than 0.50 in all the cases. It coefficients both for COP and POP were found to be
is even found to be more than 0.70 for ACC, HPCL, negative for Gujarat Ambuja, and Tata Power.
MTNL, Satyam Computer, and SBI. It indicates that the

Table 2: Summarized Results of Regression based on Open Interest-based Predictors for Individual Stock Options

S. Positive Coefficient for Call Option Open Negative Coefficient for Call Option Negative Coefficients for both
No. Interest-based Predictor and Negative Open Interest-based Predictor and Call option and Put Option
Coefficient for Put Option Open Interest- Positive Coefficient for Put Option Open Interest-based Predictors
based Predictor Open Interest-based Predictor
1. Associated Cement Company Ltd.* Tata Engineering and Locomotive Co. Ltd. Gujarat Ambuja Cement Ltd.@@
(Renamed As Tata Motors Ltd.)*
2. Bharat Petroleum Corporation Ltd.* Tata Tea Ltd.* Tata Power Ltd.*
3. Hindustan Lever Ltd.*
4. Hindustan Petroleum Corporation Ltd.*
5. Infosys Technologies Ltd.*
6. Mahindra & Mahindra Ltd.@
7. Mahanagar Telephone Nigam Ltd.@@
8. Reliance Industries Ltd.*
9. Satyam Computer Services Ltd.*
10. State Bank of India*
11. Tata Iron and Steel Company Ltd.*
* COP and POP are statistically significant at 99% confidence interval.
@COP is statistically significant at 99% while POP is significant at 95% confidence interval.
@@COP is statistically significant at 99% confidence interval while POP is not significant.

Table 3: Results based on Regression with Open Interest-based Predictors and Volume- based Predictors for
Individual Stock Options

αi (Coefficient) Standard Error t – statistic αi (Coefficient) Standard Error t – statistic

Panel A: Associated Cement Company Ltd. St 1.021 0.325 3.142
N = 714 ; R2Adjusted = 0.857 OCt 0.438 0.140 3.129
Intercept 6.232 0.310 20.103 OPt -0.308 0.078 -3.949
T–t -0.019 0.009 -2.111 VCt -1.065 0.791 -1.346
St 0.526 0.179 2.939 VPt 0.173 0.257 0.673
OCt 3.865 0.467 8.276 Panel C: Gujarat Ambuja Cement Ltd.
OPt -5.704 0.475 -12.008 N = 379 ; R2Adjusted = 0.387
VCt 0.829 0.254 3.264 Intercept 7.131 0.690 10.335
VPt 0.375 0.198 1.894 T–t -0.009 0.008 -1.125
Panel B: Bharat Petroleum Corporation Ltd. St 0.360 0.268 1.343
N = 714 ; R2Adjusted = 0.425 OCt -0.385 0.121 -3.182
Intercept 6.965 1.241 5.612 OPt -0.553 0.328 -1.686
T–t -0.005 0.009 -0.556 VCt 1.951 0.661 2.952
VPt -2.500 0.565 -4.425

VIKALPA • VOLUME 33 • NO 2 • APRIL – JUNE 2008 19

 αi (Coefficient) Standard Error t – statistic αi (Coefficient) Standard Error t – statistic
Panel D: Hindustan Lever Ltd. Panel J: Satyam Computer Services Ltd.
N = 714 ; R2Adjusted = 0.751 N = 714 ; R2Adjusted = 0.735
Intercept 3.956 0.286 13.832 Intercept 3.485 0.618 5.639
T–t 0.005 0.003 1.667 T–t -0.033 0.016 -2.063
St 0.383 0.176 2.176 St 0.477 0.495 0.964
OCt 1.583 0.286 5.535 OCt 2.098 0.660 3.179
OPt -1.948 0.197 -9.888 OPt -2.194 0.688 -3.189
VCt 0.271 0.246 1.102 VCt 3.408 0.925 3.684
VPt 0.012 0.205 0.059 VPt -1.472 0.976 -1.508
Panel E: Hindustam Petroleum Corporation Ltd. Panel K: State Bank of India
N = 714 ; R2Adjusted = 0.872 N = 714 ; R2Adjusted = 0.784
Intercept 2.232 0.341 6.545 Intercept 3.428 0.315 10.883
T–t -0.009 0.014 -0.643 T–t 0.009 0.004 2.250
St 0.750 0.296 2.534 St 0.119 0.196 0.607
OCt 3.009 0.661 4.552 OCt 1.361 0.485 2.806
OPt -1.169 0.544 -2.694 OPt -1.884 0.524 -3.595
VCt 1.460 0.592 2.466 VCt 0.340 0.318 1.069
VPt 0.355 0.583 0.609 VPt 0.417 0.267 1.562
Panel F: Infosys Technologies Ltd. Panel L: Tata Engineering and Locomotive Co. Ltd. (Renamed
as Tata Motors Ltd.)
N = 714 ; R2Adjusted = 0.551
N = 714 ; R2Adjusted = 0.622
Intercept 9.349 0.829 11.277
Intercept 8.752 0.316 27.696
T–t -0.023 0.010 -2.300
T–t -0.001 0.004 -0.250
St -0.264 0.370 -0.714
St 0.180 0.175 1.029
OCt 2.494 0.687 3.630
OCt -2.707 0.391 -6.923
OPt -1.114 0.382 -2.916
OPt 3.758 0.413 9.099
VCt 2.429 0.716 3.392
VCt 0.679 0.236 2.877
VPt 0.204 0.919 0.222
VPt -0.605 0.261 -2.318
Panel G: Mahindra & Mahindra Ltd.
Panel M: Tata Power Co. Ltd.
N = 714 ; R2Adjusted = 0.358
N = 421 ; R2Adjusted = 0.512
Intercept 6.191 0.405 15.286
Intercept 10.618 0.295 35.993
T–t -0.012 0.007 -1.714
T–t 0.005 0.002 2.500
St -0.002 0.311 -0.006
St -0.135 0.130 -1.038
OCt 0.851 0.325 2.618
OCt -1.065 0.312 -3.413
OPt -0.580 0.293 -1.980 OPt -1.957 0.235 -8.328
VCt 0.341 0.565 0.604 VCt -0.044 0.215 -0.205
VPt -0.409 0.382 -1.071 VPt 0.008 0.153 0.052
Panel H: Mahanagar Telephone Nigam Ltd. Panel N: Tata Tea Ltd.
N = 714 ; R2Adjusted = 0.848 N = 382 ; R2Adjusted = 0.319
Intercept 8.562 0.239 35.824 Intercept -0.509 0.762 -0.668
T–t 0.002 0.003 0.667 T–t -0.011 0.014 -0.786
St -0.084 0.083 -1.012 St 0.571 0.250 2.284
OCt 0.707 0.168 4.208 OCt -1.990 0.677 -2.939
OPt -0.385 0.221 -1.742 OPt 2.930 0.596 4.916
VCt -0.074 0.162 -0.457 VCt 0.601 0.537 1.119
VPt -0.167 0.103 -1.621 VPt 0.801 0.423 1.894
Panel I: Reliance Industries Ltd. Panel O: Tata Iron and Steel Company Ltd.
N = 714 ; R2Adjusted = 0.645 N = 714 ; R2Adjusted = 0.969
Intercept 2.402 0.632 3.801 Intercept 4.047 0.148 27.345
T–t 0.022 0.005 4.400 T–t 0.002 0.002 1.000
St 0.195 0.262 0.744 St -0.208 0.027 -7.704
OCt 2.832 0.417 6.791 OCt 1.338 0.136 9.838
OPt -3.598 0.431 -8.348 OPt -1.574 0.172 -9.151
VCt 0.869 0.348 2.497 VCt -0.154 0.176 -0.875
VPt 0.295 0.373 0.791 VPt 0.300 0.142 2.113

20 SIGNIFICANCE OF NON-PRICE VARIABLES IN PRICE DISCOVERY

 Further, the regression analysis has been carried out transactions are expected to be quite less. The reason is
for S&P CNX Nifty index also and the findings are sum- that while writing options one would take exposure to
marized in Table 4. The results for Nifty index are simi- the unlimited risk potential. When informed investors
lar as have been witnessed in case of individual stocks. are acting on the basis of information that would mate-
The coefficient of call option open interest-based pre- rialize in future, they are already undertaking the calcu-
dictor is positive while the same for put option open lated risk. They would like to avoid multiplying their
interest-based predictor is negative. Both are significant risk exposure by going short in the option market. Fur-
at 1 per cent level. The model also has considerably good ther, given the high degree of volatility in the Indian
explanatory power, i.e., 83.1 per cent, which indicates stock market, the probability of informed investors buy-
that it could explain around 83.1 per cent of the varia- ing options rather than writing options would be more.
tions in underlying Nifty index. Therefore, the COP is expected to have positive coeffi-
cient while the same is expected to be negative for POP.
Table 4: Results based on Regression with Open It should be noted that the study emphasizes upon the
Interest-based Predictors and Volume-based COP and POP and not the net open interest alone and
Predictors for Nifty Options
hence it needs to be seen in the light of both net open
N = 714 ; R2Adjusted = 0.831 interest and strike prices. There is a likelihood that the
αi (Coefficient) Standard Error t – statistic open interest-based predictors may increase even when
Intercept 7.404 0.368 20.120 the net open interest declines. This is due to the fact that
T–t -0.023 0.011 -2.091 investors may be dealing in the call or put options at a
It 0.625 0.213 2.934 higher strike price that leads to increase in these predic-
OC t 4.592 0.555 8.274 tors. The reverse would happen in case of increase in
OPt -6.777 0.564 -12.016 net open interest but the options are entered at a lower
VCt 0.985 0.302 3.262 strike price.
VPt 0.446 0.235 1.898 The volume-based predictors have also been stud-
ied but they do not provide any insight into the price
These findings, both for stock options and Nifty in- discovery process and hence are not expected to improve
dex options, are in line with the findings of Bhuyan and the informational efficiency of the underlying stock
Yan (2002) and have provided a further validity to the market. These findings are in line with the conclusions
results of Srivastava (2003) that was based on a relatively of Bhuyan and Chaudhury (2001) and Bhuyan and Yan
small time period. These findings provide support in (2002) that net open interest of call options and put op-
favour of the argument that the coefficient should be tions together should provide a better indication of the
positive for COP and negative for POP. This is because future stock price movement, as against the total vol-
of the fact that informed investors would buy out-of- ume considered by Easley, O’Hara and Srinivas (1998).
the-money call options (at a higher strike price level) in The results support the findings of Easley, O’Hara and
anticipation of rise in stock prices leading to an increase Srinivas (1998) to the extent that it provides evidence
in COP. Similarly, they would prefer to buy put options against the widespread belief that price in option mar-
at a higher strike price when they have specific infor- ket is unilaterally derived from the underlying stock
mation about the decline in stock prices, which would prices. In fact, the evidence suggests that option mar-
lead to a higher POP. kets, more specifically the net open interest, are likely to
Another possibility may be that the informed inves- be informative about the future movement of stock
tors may like to write put options when they expect the prices. Investors who do not possess the specific infor-
stock prices to increase and call options when they ex- mation about the future price movement can use these
pect stock prices to decline. It may be argued that the predictors for deciding upon their trading strategies.
model used in this study is based on the basic premise Even the sophisticated investors can explore these esti-
that informed investors are expected to go long only ei- mates and further refine their trading strategies with
ther on call options or put options. However, it is to be more informational inputs. Thus, the role of option in
noted that the possibility of option writing by the in- price discovery is clearly visible in the results.
formed investors is not ruled out completely but such

VIKALPA • VOLUME 33 • NO 2 • APRIL – JUNE 2008 21

CONCLUDING OBSERVATIONS gain significance in the portfolio of institutional inves-
This study has strengthened the argument forwarded tors in India. Lastly, there are some issues relating to
by Bhuyan and Yan (2002) that net open interest of stock the accounting and tax treatment of profit arising from
option is one of the significant variables in the determi- dealing in derivative securities that further prohibit the
nation of the future spot price of the underlying stock. wider participation of investors in the derivative seg-
The results clearly indicate that the open interest-based ment.
predictors are statistically more significant than the vol- Our research contributes to the existing literature by
providing some evidence of option market activity and
ume-based predictors in the Indian context too. How-
ever, there are certain differences in the outcome of this the impact of non-price variables on the future spot price
study and Bhuyan and Yan (2002). According to their of underlying asset in the context of a developing na-
study, the coefficient of COP has a positive sign and the tion like India where derivatives have been recently in-
coefficient of POP possesses a negative sign. Based on troduced in the stock market. As the market activity
these findings, they argue that the informed investors progresses further, we hope that more evidence would
would buy out-of-the-money call options when they come in support of our findings. It would not only ben-
expect the market to rise and put options when they efit the investor community but also provide support
expect it to decline. The reasoning, as mentioned in the for the hypothesis that derivative securities enhance the
quality of the underlying asset market. This study also
previous section, does support their contention. How-
ever, we have given the additional explanation for this complements the earlier evidence documented in
to happen which would be more relevant in the context Srivastava, Yadav and Jain (2002) with regard to the ef-
of volatile markets like India. This explanation is with ficiency of stock index futures market in India. It would
regard to the trading behaviour of informed investors definitely help the regulatory bodies in policy-making
in the Indian market. and further strengthening the efforts to promote the
There may be a number of reasons for the difference derivative market in India. There are many areas which
in results arrived in the contexts of the US and India. are still unexplored and can be addressed by the future
Firstly, the exchange traded stock derivative market in studies.
India is of recent origin and it takes time for the inves- First and foremost is the use of intraday data in de-
tors to realize the true potential of these instruments. termining the significance of net open interest because
Secondly, the participation of institutional investors in many profitable opportunities are utilized within a
the Indian stock derivative market is extremely limited. course of day and hence future studies may take up
It can be attributed to the regulatory restrictions wherein this aspect into consideration. We have used a sample
such investors are allowed to use derivative securities of 15 near-month stock options for the present study
mainly for hedging and arbitrage purposes only. The because they are most liquid. As the number of stocks
story of mutual funds is not much different from them. in the stock option segment has been increased to 118, a
future study may be conducted with a larger sample size
Therefore, the investors who have a better access to in-
formation and can be classified in the category of in- and a longer duration data. Lastly, the significance of
formed investors are constrained to deal in the derivative daily change in open interest in predicting the future
securities. Though there are some positive developments spot price may be another area that can be explored by
taking place in this direction, these securities are yet to the future studies.

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Sandeep Srivastava is currently a Senior Executive with Ernst He has contributed more than 30 articles in financial/economic
& Young, looking after the company’s operations in the Mid- newspapers.
dle East. He holds an M.Phil. from the University of Delhi and
a Ph.D. from the Department of Management Studies, IIT e-mail: [email protected]
Delhi. His major interests are stock market behaviour and risk
management. P K Jain is a Professor of Finance and holds the Modi Founda-
tion Chair. He has a teaching experience of more than 30 years
e-mail: [email protected] in subjects related to Finance and Accounting. He has taught
at the University of Paris and is a Visiting Professor at the ICPE,
Surendra S Yadav is currently a Professor and the Head of Ljubljana. He has authored/co-authored more than a dozen
the Department of Management Studies, IIT Delhi. He teaches text books and research books in the area of finance and ac-
Corporate Finance, International Finance, International Busi- counting and has published more than 120 research papers in
ness, and Security Analysis and Portfolio Management. He national and international journals. His contributions in the
has been a Visiting Professor at the University of Paris, Paris field of Finance have been recognized at national and interna-
School of Management, INSEEC Paris and the University of tional levels.
Tampa, USA. He has published nine books and contributed
more than 110 papers in research journals and conferences. e-mail: [email protected]

VIKALPA • VOLUME 33 • NO 2 • APRIL – JUNE 2008 23