Impact of Derivative Trading on Liquidity of the Underlying Asset: Some Evidences from the Indian Securities Market

This study attempts to examine the impact of derivative trading on liquidity of the underlying asset (individual stock) in Indian securities market. The derivative trading in Indian market commenced on June 12, 2000 when futures on S&P CNX Nifty were floated for the very first time. Later on, options on S&P CNX Nifty and options and futures on individual stocks were introduced. The study covers a period of almost seven years starting from November 19, 1998 to September 16, 2005 and the scope of the study is confined to the select individual securities on which futures and options have been floated till September 26, 2003. The period of study has been divided in four overlapping samples consisting of different individual stocks therein based on the introduction of derivative trading on individual stocks. In order to gauge the impact on liquidity, all the four samples have been examined on the three criteria, namely, (i) turnover by volume, (ii) turnover by relative volume and (iii) volatility of volume across all the sub periods of 750 days, 500 days, 250 days and 120 days. The results of the study are not very encouraging regarding the positive impact of derivative trading on liquidity. The impact on the liquidity could not be properly ascertained as there were other events like introduction of rolling settlement during the period of the study that had a significant impact on the overall liquidity in the Indian stock market.