The Securities and Exchange Board of India’s (SEBI) revised Closing Auction Session (CAS) framework could help address the sharp price swings on derivatives expiry days, but its effectiveness will depend on liquidity, market participation and how quickly traders adapt to the new system, according to Chandan Taparia of Motilal Oswal Financial Services.
Markets regulator SEBI, after receiving feedback from market participants and reviewing concerns about price volatility and derivatives settlement, revised the CAS framework on Thursday, changing closing auction timing and the methodology for determining settlement prices for stock and index derivatives contracts.
Speaking to ET NOW, Taparia stated that SEBI’s consultation paper had outlined two options – a blended volume-weighted average price (VWAP) approach combining the continuous trading session and the closing auction, and a return to the traditional 30-minute VWAP methodology, with the implementation of CAS deferred by a year.
SEBI’s CAS framework: Why blended VWAP matters
Under the blended approach, the VWAP of trades executed between 3 pm and 3:30 pm would be combined with the average price derived from the 10-minute closing auction session between 3:30 pm and 3:40 pm.
“Earlier in the normal VWAP, there used to be so much volatility between 3 pm and 3.30 pm, or in fact, the volatility started to happen at 3 pm. And that is the reason that option traders, buyers and sellers used to get the huge movement and swing on the other side. And then the CAS started,” he noted.
“In CAS, the price discovery was comparatively more fluctuated because of their indicative price, where the price was being quoted plus minus 3% from the reference price of first 15 minutes from 3 pm to 3.15 pm. So, I believe if that happens, the combination of 30 minutes VWAP plus blended 10 minutes average,” Taparia said, adding that the revised mechanism could help address the volatility witnessed under the earlier arrangements.
Sebi had introduced the CAS framework in the equity cash segment from August 3 to determine the closing price of securities. Under the existing framework, the closing price determined through CAS also serves as the basis for calculating settlement prices of derivative contracts on expiry.
The CAS aimed at improving closing price discovery and aligning India’s market practices with international standards. However, the mechanism triggered concerns among traders about sharp price movements, particularly around derivatives expiry.
Following concerns over this methodology, Sebi proposed changes in September and issued a consultation paper seeking public comments.
According to Taparia, combining the 30-minute VWAP with the closing auction price could help address these concerns. However, he cautioned that market participants would need time to understand and adjust to the revised framework.
“Slow and steady, the market will adjust and digest the changes. But liquidity is an important part to make this system feasible and viable in the derivatives market,” he said.
Will the revised CAS framework attract more liquidity?
Liquidity remains one of the biggest challenges for the closing auction mechanism. Taparia said, “If first 30 minutes VWAP is considered, already we used to have the volume weightage average and the volume in that 30 minutes. But now, if they consider VWAP plus CAS blended, however, the VWAP will give more weightage, but still the liquidity is required.”
The revised framework is expected to test whether sufficient participation can be attracted to the closing auction to support reliable price discovery. Participation from institutional investors, fund houses and other market participants could play an important role in improving liquidity over time.
Taparia also noted that the regulator had reconsidered the framework after traders reported difficulties with the initial CAS arrangement.
He said the market would require time to digest the changes, adapt to the revised trading schedule and establish liquidity in the closing auction session.
Expiry-day trading changes: What should traders expect?
Under the revised framework, the 10-minute closing auction session will operate from 3:30 pm to 3:40 pm on all trading days, while trading in index and stock derivatives will continue until 3:45 pm, with certain exceptions for expiring index derivatives contracts, Sebi said in its circular.
Taparia said the distinction between expiry-day and non-expiry-day trading sessions could help address some of the volatility concerns, particularly those arising from sharp movements in indicative prices. He pointed to recent expiry-day movements, when indicative prices reportedly showed swings of 300-400 points in the Sensex and 50-150 points in the Nifty.
“I think that can be a good thing because, ultimately, people try to fluctuate CAS to get the spot in their favourable scenario,” he said.
Taparia added that returning to a settlement calculation based on the 3 pm to 3:30 pm VWAP could be preferable in the near term. Once adequate liquidity develops in CAS, the regulator could consider how best to integrate the two mechanisms.
“We have seen that in indicative price, Sensex moves by 300 to 400 points, Nifty moves by 50 to 150 points. So if on expiry day they keep till 3 pm to 3.30 pm based on the VWAP, based on the old system, I think that will be better. But again, earlier they realized that people put so much order at 3 pm to get the VWAP in their favourable and that’s why they wanted to get some solution and based on the international practice, they changed the system from normal trading to 3.15 pm and then taking the VWAP reference and the CAS. But the indicative tick itself was the reason for this fluctuation in the price,” he said.
“I think the blend of VWAP plus CAS would be good but if they continue only till 3.30 for VWAP. I think the same old situation will be better. And once they get the liquidity in the CAS, they can again plan on how they can combine with the blend of the VWAP and the CAS,” Taparia further said.
However, he cautioned against drawing firm conclusions about the impact of the revised expiry-day arrangements before the market has had time to adjust.
He added that building liquidity could be a challenge during the initial phase of implementation.
Can CAS improve price discovery during index rebalancing?
Beyond derivatives expiry, the changes are aimed at improving transparency and price discovery, including during index rebalancing and net asset value (NAV) calculations, while ensuring a more orderly closing process.
Taparia said aligning Indian markets with international practices remained was the ultimate aim, but the limited participation of investors in the price-discovery mechanism posed a challenge.
“That’s why the real aim of the CAS was not sold and that’s why we were finding concern based on them. But the ultimate aim is how they get the proper NAV, the index rebalancing and all other things,” he highlighted.
He added that greater participation from fund houses, institutional investors and other market participants would be important for the mechanism to deliver its intended benefits.
“But I think slow and steady it will take time if more participants act on the same, if more liquidity happens from the fund houses, different types of institutes, I think then purpose of matching the interest rate standard will be sorted,” Taparia said.