The closing auction session (CAS), introduced to make end-of-day price discovery more robust, is turning into a source of anxiety for traders as sharp swings, thin liquidity and unpredictable movements in derivatives premiums weigh on participation.
The concerns came to the fore on Thursday, when the BSE Sensex witnessed its sharpest swing yet during the closing auction. The index’s indicative closing level plunged by nearly 2,200 points at one stage – from 77,200 to 74,983 – before recovering sharply. It eventually closed 249 points below its 3:15 PM level. The volatility coincided with the monthly expiry of derivative contracts on the index.
Spillover into Derivatives
That was not all. The turbulence spilled over into the derivatives market with a Bankex put option with a strike price of 64,000, for instance, surged from Rs 1.70 to Rs 68.55 during the auction — a jump of nearly 4,000%, according to Bloomberg. A put option is a financial contract that gives the buyer the right, but not the obligation, to sell a specific asset at a set price within a specific timeframe.
NSE had witnessed sharp swings in option premiums during its monthly expiry on Tuesday as well, though the movements were less pronounced.
Market experts warn that repeated bouts of such volatility could become a major hurdle to building participation and liquidity in the closing auction — the very ingredients needed for the mechanism to function efficiently.
Tejas Shah, head – trading at Equirus Securities, attributed Thursday’s sharp movement in the cash market to high impact costs in index heavyweights amid thin liquidity and muted participation. The same factors, he said, contributed to the dramatic moves in BSE options.
Chandan Taparia, head – derivatives and technicals at Motilal Oswal Financial Services, said option writers, who have benefited from the expansion of the futures and options market in recent years, are particularly vulnerable because expiring contracts are not seeing the usual premium decay – the loss of value as the expiry comes closer – during the auction.
Thin volumes combined with uncertainty are also hurting the confidence of option traders, writers and algorithmic traders, he said. The impact extends to proprietary desks, institutional investors, retail and HNI traders, as well as participants relying on technical analysis and candlestick charts.
Even backtesting — a key tool used by traders to develop and validate strategies — is being disrupted by the unusual price behaviour during the closing auction, Taparia said.
Rising Financial Risks
The consequences are not limited to sentiment. Traders are also facing mounting financial risks, prompting many to cut positions before the auction begins at 3:15 PM.
“They are losing money even if they carry small positions,” Taparia said, adding that losses arising from volatility and uncertainty during CAS are pushing a significant number of participants to unwind positions before the regular trading session ends.
The impact can be particularly severe in indices with fewer constituents, such as Bankex, and in relatively less liquid indices, where individual orders can have an outsized effect on prices. Some of the recent instances of weak Nifty openings are also being attributed to sharp movements during the previous day’s closing auction.
Shah suggested temporarily narrowing the permissible order band from the current +/-3% around the reference price until market participants become more familiar with the closing auction mechanism. Such a move, he said, could help contain erratic price action.
While most believe that CAS is a positive measure over the long term, but said adequate liquidity is critical for its benefits to reach investors and traders. He also favoured reviewing the current 3% order range around the reference price to curb excessive volatility.