"Islamic Finance Researches" (IFR)

The Impact of Stock Option Trading Volume on Stock Market Price in an Islamic Capital Market: A Case Study of the Automotive Industry

Document Type : Science - Research (Islamic Risk Management Tools)

Authors

1 Associate Professor, Department of Economics, Faculty of Economics, Management and Administrative Sciences, Semnan University, Semnan, Iran

2 Associate Professor, Department of Accounting, Faculty of Economics, Management and Administrative Sciences, Semnan University, Semnan, Iran

3 .A. Canditate Accounting, Department of Accounting, Faculty of Economics, Management and Administrative Affairs, Semnan University, Semnan, Iran

4 M.A. Canditate Accounting, Department of Accounting, Faculty of Economics, Management and Administrative Affairs, Semnan University, Semnan, Iran

10.30497/ifr.2025.246806.1905

Abstract

1. Introduction and Objective
Options contracts, as one of the most widely used derivative instruments in modern financial markets, have traditionally been viewed primarily as risk management tools. They are designed to hedge against adverse price fluctuations and to mitigate volatility in the spot market. In this conventional perspective, derivatives are meant to stabilize financial systems and enhance market efficiency by allowing investors and institutions to transfer or redistribute risk. Yet, research in both developed and emerging markets increasingly demonstrates that the trading of derivatives, far from being neutral, can actively influence the pricing of the underlying assets. This dual function of derivatives—simultaneously reducing risk and transmitting information—has become a focal point of financial economics.
      The case of stock options is particularly notable. These instruments, while structured to provide investors with flexibility in exposure to underlying assets, can exert feedback effects on stock prices themselves. The mechanisms through which such impacts emerge include the information content embedded in option trading, the behavioral reactions of market participants, and liquidity spillovers from derivative markets into the spot market. For instance, heavy trading in stock options may be interpreted as a signal of changing expectations, thereby prompting adjustments in stock valuations even before fundamentals shift.
      In the context of Islamic capital markets, such as Iran’s, the analysis acquires additional layers of importance. Given the emphasis on transparency, the prohibition of excessive uncertainty (gharar), and the need to prevent speculative manipulation (maysir), understanding how derivative markets interact with stock markets is not merely a technical issue but also a normative concern. Derivatives in Iran have developed only recently, with limited depth and a relatively small number of tradable contracts compared to international standards. Yet, their influence on stock markets, particularly in key sectors like the automotive industry, appears to be significant.
      The central objective of this study, therefore, is to empirically examine the effect of stock option trading volume on the stock prices of automotive companies listed on the Tehran Stock Exchange (TSE). The research seeks to determine whether option trading volume operates as a meaningful signal that shapes investor expectations and stock price dynamics in a shallow but growing derivative market. This focus combines empirical analysis with policy relevance, offering insights for investors, regulators, and scholars of Islamic finance alike.
2. Methods and Materials
The research population consists of automotive companies listed on the Tehran Stock Exchange whose shares, as well as their corresponding stock options, are actively traded. This sector was selected because it is both a major component of Iran’s stock market and one of the earliest to adopt derivative instruments. The presence of simultaneous activity in both the spot and options markets makes it an ideal case study for exploring cross-market dynamics.
      The dataset spans multiple trading periods and incorporates daily observations of stock prices and option trading volumes. In order to handle the characteristics of the data—specifically its time-series and panel structure—the Panel Autoregressive Distributed Lag (Panel ARDL) model was employed. This methodology is particularly suitable for datasets where variables may exhibit mixed levels of integration (I(0) and I(1)) and where both short-term and long-term relationships need to be captured. By using Panel ARDL, the study is able to assess not only the immediate impact of option trading volume on stock prices but also the persistent, long-term effects that may materialize over time.
      The variables of the study are defined as follows:
- Dependent variable: Stock prices of automotive companies.
- Independent variable: Trading volume of stock options linked to these companies.
- Control considerations: Structural features of the TSE, liquidity constraints, and statistical diagnostics to confirm the appropriateness of the ARDL framework.
      In addition, robustness checks were performed to ensure that results were not driven by spurious correlations or by the shallow nature of the derivative market. The use of panel data strengthens the empirical results by pooling information across multiple firms, thereby increasing statistical power and reducing the risk of bias due to firm-specific anomalies.
3. Research Findings
The empirical findings reveal a positive and statistically significant relationship between option trading volume and stock prices in the automotive sector of the Tehran Stock Exchange. More specifically, as the trading activity in stock options increases, the underlying stock prices show a corresponding upward movement. This relationship holds in both the short-term fluctuations captured by the ARDL lags and in the long-term equilibrium dynamics implied by the model.
       Two central insights emerge from the analysis:
1. Market Sensitivity to Derivatives: The spot market in Tehran is responsive to developments in the derivatives market, even though the latter is shallow and relatively new. Option trading activity carries informational value that market participants interpret as signals about future price trajectories.
2. Signaling Function of Trading Volume: The trading volume of stock options effectively operates as a predictor of stock price behavior. Investors observing heightened option activity tend to become more optimistic, anticipating rising prices in the underlying assets. This behavioral channel amplifies the impact of derivative markets on stock valuations.
      The magnitude of the effect, while varying across companies, is consistently positive, underscoring the robustness of the results. Interestingly, the influence appears more pronounced in periods of heightened market volatility, suggesting that in uncertain conditions investors rely more heavily on derivative signals to form expectations.
4. Discussion and Conclusion
The findings of this study carry several theoretical, practical, and policy implications. From a theoretical standpoint, they validate the proposition that derivative markets, far from being mere hedging platforms, can exert direct influence on spot markets through informational spillovers and behavioral feedback loops. This perspective is consistent with international literature but acquires distinctive significance in emerging Islamic markets like Iran’s, where the institutional framework is still developing.
      From a practical perspective, the positive association between option trading volume and stock prices highlights the importance of monitoring derivative markets for investment decision-making. Investors who pay attention to option market signals may be better positioned to anticipate stock price trends. Conversely, ignoring derivative activity risks missing critical information embedded in market dynamics.
      From a regulatory and Islamic finance perspective, the results raise both opportunities and cautions. On the one hand, the derivative market can enhance price discovery and provide valuable signals that improve market efficiency. On the other hand, the shallow depth of Iran’s derivative market magnifies the risk of speculative manipulation, excessive volatility, and practices that may conflict with Islamic principles such as gharar and maysir. Policymakers must therefore strike a balance: encouraging the healthy growth of derivatives as part of capital market development while instituting strong oversight to prevent abuse.
      The study concludes that option trading activity in Iran, particularly in the automotive industry, should not be dismissed as marginal. Instead, it represents a critical element of market dynamics that influences stock price formation. Strengthening oversight, improving transparency, and aligning derivative instruments with Islamic financial principles will not only reduce the risks of manipulation but also unlock the potential benefits of derivatives in supporting more efficient and stable capital markets.
      In summary, the research provides empirical evidence that derivative activity, even in its early stages of development in Iran, significantly affects spot market outcomes. It highlights the interconnectedness of financial instruments and underscores the need for integrated policy approaches in Islamic capital markets. Future research could expand the analysis to other sectors, explore alternative derivative products, and further examine the interplay between Shariah compliance and market efficiency.

Keywords

Main Subjects

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Volume 14, Issue 2 - Serial Number 32
November 2024
Pages 431-462
  • Receive Date: 12 August 2024
  • Revise Date: 10 April 2025
  • Accept Date: 11 May 2025