CAS First Month Raises Questions Over Derivative Settlement
India's new Closing Auction Session (CAS) is in its first month, and early data has raised questions about how derivative contracts should be settled under the new closing mechanism.
On September 3, hours before the Sensex weekly expiry, SEBI said it was reviewing how derivative settlement prices are determined under CAS. A consultation paper is expected within a week.
CAS went live on August 3, replacing the 30-minute VWAP-based closing mechanism with a call auction. F&O stocks stop trading at 3:15 pm, orders are collected during the auction period, and a single clearing price is calculated between 3:20 pm and 3:30 pm.
The aim was to produce a cleaner and more difficult-to-manipulate closing price. But data from two of the four weekly Sensex expiries suggests that when liquidity is weak, the mechanism can make sharp swings.
Two Thursdays, Same Pattern
On August 27, the Sensex’s low in the CAS window was an illiquid Indicative Equilibrium Price (IEP) of 74,964, exactly at the -3% floor. The index moved 2,171 points during the auction period.
The pattern was the same on September 3. The low was an illiquid IEP of 74,268, again falling below the -3% limit, with the index swinging 2,658 points.
The contrast with the August 31 MSCI India rebalance is significant. Around Rs 39,000 crore of CAS value was generated, but the auction cleared orderly. The September 3 Sensex expiry auction only involved Rs 126 crore of turnover, but the index moved about 2,000 points.
We find this indicates liquidity and order direction are more important than transaction size.
The Derivatives Gap
The key issue is timing. Index derivatives continue trading until 3:40 pm while the underlying market is in the CAS process. The IEP is only a projection of where the order book would clear if matched at that moment.
No transaction has taken place at the IEP until the final auction match. But derivatives traders can continue pricing and hedging against the evolving figure, and expiry contracts eventually settle against the final cash-market value.
The situation also echoes SEBI's Copthall/Mansi order, where orders were allegedly used to influence the IEP before being withdrawn ahead of the final match.
What Could Change?
Possible measures include reducing the time of the CAS window to less than 5 minutes, allowing only limit orders, restricting cancellations, and not displaying live IEP as a price before an actual trade takes place.
SEBI could also temporarily tighten the permitted band from 3% to 1% in affected instruments.
This first month shows CAS works well when liquidity is strong, and flows are balanced. The next challenge is to ensure that derivatives do not have to trade against a projected price while the actual closing price is still to be discovered.
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