The Securities and Exchange Board of India (SEBI) is set to issue a consultation paper next week to review the methodology for determining settlement prices of derivative contracts on expiry, following market participant feedback on the new Closing Auction Session (CAS). As per The Economic Times, this review comes after August saw a significant dip in equity derivatives turnover on the NSE and BSE, reaching multi-month lows. The regulator stated that among the issues raised, a significant area relates to the determination of settlement prices of derivative contracts on expiry based on the closing price determined through CAS. Two people aware of the discussions suggest that while the daily CAS will continue as before, SEBI may propose settling weekly and monthly derivatives using the previous volume-weighted average price (VWAP) model, or using a combination of VWAP and CAS prices to smooth out last-minute swings on settlement days. HDFC Securities reports that plausible fixes include tighter auction price bands, an extended or overlapping derivative session, restrictions on late order entry, and settling index derivatives on a VWAP spanning the pre-auction and auction windows, noting these changes would be volume-accretive. According to The Hindu BusinessLine, market participants also expect SEBI to examine the price band for the auction and the timing of cash and derivatives trading, with another suggestion to align the expiry of index derivatives more closely with the cash-market session.
The introduction of the Closing Auction Session has fundamentally changed trading dynamics near market close, with traders opting to exit their positions sooner to avoid potential pitfalls. According to The Economic Times, traders reported sudden option price swings during the auction window, creating volatility concerns. However, SEBI has reassured that this session mechanism is now a permanent feature of the market structure. The regulator is expected to consider delinking derivative settlements from CAS closing prices rather than scrapping the mechanism entirely, which could reduce sharp expiry-day swings while maintaining normal market volatility. HDFC Securities notes that CAS was introduced to align India with global closing-price practice and remove the 30-minute VWAP window as a manipulation vector, but the design is sound while the rollout was not, with uncertainty around the auction-determined closing price keeping option writers on the sidelines. Baheti highlights that the issue lies in settling the entire derivatives settlement price based on the closing auction price, which creates unnecessary volatility until the CAS session achieves sufficient liquidity and depth. As per The Hindu BusinessLine, the timing gap means option writers cannot hedge against a closing price that is yet to be determined, with thin participation in the auction further reducing predictability.
Recent market data has revealed sharp, unexplained price swings on expiry days, including a drop Baheti described as "a 2,000-point drop in the Sensex, a 2,500-point drop in the BANKEX on the day of the monthly BSE expiry." As per CNBC TV18, aggressive order cancellations have emerged as a key risk factor, with traders placing buy orders above closing prices or sell orders below closing prices and then modifying or canceling them at the last moment. HDFC Securities attributes the initial weakness to uncertainty around the auction-determined closing price, noting that since cash trading ends at 3:15 pm while index options continue until 3:30 pm, option writers are unable to hedge against a closing price that is not yet known. The entire expiry-day trade has become a kind of lottery, creating an anomaly that makes the risk go up and discourages trading. The brokerage believes these changes would be volume-accretive, citing the example of Hong Kong which launched a closing auction in 2008 but withdrew it in 2009 after end-of-day price swings and reintroduced it in 2016 with price limits and other changes.
Since CAS was introduced for 213 stocks eligible for derivatives trading, settlement occurred at prices discovered in thinly traded auctions held at 3:15-3:30 pm. Essentially, options contracts with premium value in tens of thousands of crores of rupees were settled based on prices reached in a thinly traded auction of ₹1,200-1,300 crore between NSE and BSE. As per The Economic Times, by distorting the index stock prices during the auction on settlement days, the index options positions taken prior to the auction could swing wildly, causing a divergence between the values of the Nifty and Sensex. The continuous trading session for eligible cash stocks closes at 3:15 pm, while derivatives trading continues until 3:40 pm, with orders placed between 3:20 pm and 3:30 pm and closing prices discovered based on maximum bids and offers between 3:28 pm and 3:30 pm. These prices are released at 3:35 pm and used for settlement at 3:40 pm. HDFC Securities notes that most global markets settle index derivatives on the auction price itself, or on an average that spans the auction, so hedging stays possible right through, while India stops cash trading fifteen minutes before the derivative session ends, which leaves a gap nobody can hedge. Market participants have also suggested retaining CAS for determining the cash-market closing price while using a separate VWAP-based price for derivatives settlement, with other proposals including tighter price bands and restrictions on late order entry.
CAS, which went live on August 3, has triggered a sharp decline in derivatives activity, with BSE's options premium average daily traded value (ADTV) falling 26% month-on-month to about ₹187 billion in August. According to HDFC Securities, industry-wide premium ADTV declined 19% to ₹610 billion, with BSE's notional ADTV dropping to ₹153.6 trillion from ₹232.2 trillion in July. However, signs of recovery have emerged, with BSE's premium ADTV rising 18% week-on-week to ₹228 billion, although it remains about 23% below the first-quarter FY27 level. The brokerage expects BSE's premium ADTV to rise to ₹255 billion in FY27 and ₹315 billion in FY28, with market share reaching 30.7% and 33.7% respectively. HDFC Securities has maintained its 'Add' rating on BSE, saying the regulatory impact from the new closing auction session is behind the exchange and recovery has begun, with derivatives volumes now set for recovery. The disruption was concentrated in derivatives and expiry-day activity rather than reflecting a broader withdrawal of market participation, with BSE's cash ADTV increasing to about ₹106 billion in August from ₹99 billion in July.
