Impact of stock derivatives trading on spot price volatility in India

The beginning of stock derivative trading world over has increased the debate on the impact of futures and options trading on spot price volatility. Mainly there are two types of theory in the literature explaining the impact of stock derivative trading on spot price volatility. The proponents of the first type of theory are of the view that the introduction of futures trading increases the spot market volatility. The other school of thought argues that the introduction of futures reduces the spot market volatility. The empirical research on this issue has generated controversial results. Accordingly, in our study we have made a sincere effort to examine the impact of stock derivative trading on spot price volatility in India in its relatively matured stage. For examining the impact of futures and options contracts on spot market volatility we have applied GARCH model. From the major findings of the study we can conclude that the introduction of futures and options contracts reduces the spot market volatility. Further the volatility in the underlying stock market has declined more after the introduction of both futures and options contracts and hence options trading leads to stabilization of the Indian spot market significantly more.