Testing the Efficiency of Indian Options Market

Master's Thesis from the year 2014 in the subject Business economics - Investment and Finance, grade: A, University of Calcutta, language: English, abstract: The present study is conducted to test the efficiency of Indian options market. Very few studies have been conducted to test the efficiency of Indian derivatives market and especially Indian options market. This study is essential for testing the price discovery of the Indian options market. This study is motivated by lack of evidence and fills this gap by providing hitherto unavailable evidence on efficiency of the Indian options market. The purpose of the study is to test the efficiency of Nifty stock options. The study is done using trading data for 1 month. Market efficiency is tested by examining the validity of the put-call parity and of the hedging strategy. Black-Scholes model of option pricing is used to determine the fair option prices in this study. In case of mispricing of options contracts, hedging test is conducted to ascertain whether above normal returns are possible by taking advantage of the mispricing. In hedging test returns are calculated after the trader closes his position in the spot market. These returns are then compared to risk-free returns. When transaction costs are not taken into account, the hedging returns were more than the risk free returns for some stocks which showed that the market is inefficient. But after transaction costs are considered these returns became negative and ascertained that the market is efficient. Put-call parity test in the absence of the transaction costs showed that options market is inefficient. However in the presence of these costs, the hypothesis of market efficiency is accepted. The present study will help to get useful insights so that the options markets can be made more efficient as healthy financial markets are backbone of any financially healthy country. Furthermore, financial markets should be efficient and efficiency helps to prevent any kind of frauds in the financial markets.