Indian hedgehog (Ihh) controls multiple aspects of endochondral skeletal development by signaling to both chondrocytes and perichondrial cells. Previous efforts to delineate direct effects of Ihh on chondrocytes by Col2-Cre-mediated ablation of Smoothened (Smo, encoding a transmembrane protein indispensable for Ihh signaling) has been only partially successful, due to the inability to discriminate between chondrocytes and perichondrial cells. Here we report a transgenic line (Col2-Cre) expressing under the control of the Colalpha1(II) promoter an inert form of Cre that is activatable by exogenous tamoxifen (TM); TM administration at proper times during embryogenesis induced Cre activity in chondrocytes but not in the perichondrium. By using this mouse line, we deleted Smo within subsets of chondrocytes without affecting the perichondrium and found that Smo removal led to localized disruption of the expression of parathyroid hormone-related protein (PTHrP) and the morphology of chondrocytes. Unexpectedly, TM invariably induced Cre activity in a subset of cells associated with the trabecular bone surface of long bones. These cells, when genetically marked and cultured in vitro, were capable of producing bone nodules. Expression of the Col2-Cre transgene in these cells likely reflected the endogenous Colalpha1(II) promoter activity as similar cells were found to express the IIA isoform of Colalpha1(II) mRNA endogenously. In summary, the present study has not only provided evidence that Ihh signaling directly controls PTHrP expression and chondrocyte morphology in the growth region cartilage, but has also uncovered a distinct cell type associated with the trabecular bone that appears to possess osteogenic potential.