Trading restriction and the choice for derivatives

In this paper, we explore how trading restriction in terms of significantly increased cost for futures contracts impacts trading activities of futures and options written on the same underlying asset. In particular, we are interested in examining whether the two derivatives markets complement each other or are substitutes. Using daily data of futures and options written on the Shanghai Stock Exchange 50 Exchange Traded Open-end index from April 2015 to October 2019, we show that the regulatory trading restriction substantially reduces the trading volume and open interest in the futures market and increases those in the options market. Furthermore, the gradual relaxation of the restriction pushes up trading activities in the futures market, but does not necessarily reduce those in the options market. Hence, our results suggest that the two derivatives markets complement each other, which advance our understanding of investor behaviour and shed new light on how best policies can be designed to improve market quality.