Studies in Indian equity derivatives market

Abstract

Indian equity derivatives market is one of the largest derivatives markets in the world, with highly liquid index futures, Single-stock futures (SSFs), index options and Single-stock options (SSOs). We explore the dynamics of this market across three studies. In the first study, we show that price-discovery gravitates towards index futures due to leverage and short-sell benefits of futures and due to lower information asymmetry in basket products like ETFs and index futures. We disentangle the ‘Leverage’ and ‘Basket’ effects and find that the latter dominates. We also employ a novel methodology to control for the asynchronous bias in the results by computing optimal estimators of the equity cash index. Using a dataset of about 200 million trades, we find a 65:35 split between futures and spot after controlling for the bias. We also quantify the role of top-down market-wide information flow. In the second study, we explore the pricing of SSOs and index options using a dataset of over two million contracts. Our findings are supportive of market efficiency: a parsimonious smile-adjusted Black-model fits option prices well, there is a modest risk-premium embedded in option prices, and the implied volatility has incremental predictive power for future volatility. In the third study, we explore the use of SSFs to exploit private information. Studies in the US report high SSO volume before earnings announcements (EA). Our analysis in India where the SSFs are also liquid, show that SSFs dominate SSOs possibly due to SSOs becoming expensive before EA and higher information leakage. This indicates that traders prefer embedded leverage and short-sell provisions provided by the SSFs and do not use options' downside-risk protection. Hence, the SSF market plays the role in India that is played by SSO market in the US. Our findings contribute to a holistic understanding of the Indian equity derivatives market.