India’s markets regulator has proposed changes to the way settlement prices for index and stock derivatives are calculated on expiry days, following concerns over heightened market volatility associated with the newly introduced Closing Auction Session (CAS).
The Securities and Exchange Board of India (SEBI) outlined the proposals on Saturday in a consultation paper seeking public feedback on possible changes to the CAS framework. The regulator is considering two alternative approaches to determining expiry-day settlement prices for derivatives.
Under the first option, the settlement price would be calculated using a combination of trades executed during the final 30 minutes of regular trading and the 10-minute closing auction. This approach would retain a link between the derivatives market and the closing auction while attempting to reduce the impact of sharp price movements during the final phase of trading.
The second option would temporarily exclude the closing auction from the calculation altogether. Under this proposal, derivatives settlement prices would once again be based solely on trading during the final 30 minutes of normal market hours, effectively separating derivatives settlement from the CAS framework for at least one year.
The proposals come after the CAS was introduced in the equity cash segment on August 3 for stocks that have corresponding derivatives contracts. The system was designed to improve the efficiency and transparency of the process used to determine securities’ closing prices.
However, the introduction of the auction mechanism has coincided with sharp swings in the market on derivatives expiry days, prompting the regulator to examine whether changes are needed to prevent distortions around the market close.
SEBI is also proposing a series of other adjustments to the closing-auction framework.
One proposal would prevent traders from cancelling limit orders placed more than 1% above or below the reference price. The regulator is also considering shortening the post-closing auction trading window for derivatives from 10 minutes to five minutes.
Another proposed change would stop the dissemination of indicative index closing levels during the closing auction. However, SEBI has proposed continuing to publish the indicative equilibrium price for individual stocks during the auction.
The regulator has invited market participants and other stakeholders to submit comments on the proposals by October 3.
Market analysts said the proposals should be viewed as an attempt to fine-tune the new system rather than abandon it.
"SEBI is not backing away from CAS. Instead, it is trying to refine CAS after observing expiry-day behaviour," said Rajesh Palviya, senior vice president and head of research at Axis Securities.
"The key objective is to reduce the disconnect between cash-market price discovery and derivatives trading near the close," Palviya said.
The debate over settlement prices is particularly significant because expiry-day trading can involve large volumes of derivatives positions being closed or rolled over. Even relatively small movements in the underlying cash market can have a substantial effect on derivative positions, potentially amplifying volatility toward the end of the trading session.
SEBI’s two proposed approaches represent different ways of addressing that problem. The first would preserve the role of the closing auction while combining it with regular-market activity, whereas the second would temporarily remove the auction from derivatives settlement altogether.
The consultation is therefore likely to draw close attention from exchanges, brokers, institutional investors and derivatives traders, as the regulator seeks to balance transparent price discovery with the need to limit excessive volatility around expiry.
The proposals do not amount to a final decision. SEBI will consider the feedback received from market participants before deciding whether, and in what form, to implement the changes.