SEBI Retains Closing Auction Session Despite Expiry Day Volatility

The Securities and Exchange Board of India (SEBI) has confirmed that the newly implemented Closing Auction Session (CAS) will remain a permanent feature of the Indian equity markets. Chairman Tuhin Kanta Pandey announced the decision on Wednesday, even as the regulator acknowledged the need to overhaul the methodology used to determine derivative settlement prices on expiry days. The announcement followed a period of intense market turbulence, where the CAS window triggered significant price swings that left many traders struggling to navigate the final minutes of the session.

On Thursday, the benchmark Sensex and Nifty 50 indices experienced a dramatic 14-minute period of volatility during the closing auction. For the majority of the trading day, the indices remained relatively flat, confined to a narrow band. However, as the CAS window opened, the Sensex surged by 1,078 points, or 1.45 per cent, within eight minutes, before eventually retreating to close at 74,902.59. Market participants noted that the indices traded at levels during the auction that were not seen at any other point during the day, highlighting the disruptive nature of the current settlement mechanism.

Addressing concerns on the sidelines of the Global Fintech Fest in Mumbai, SEBI Chairman Tuhin Kanta Pandey defended the technical implementation of the CAS. He noted that the mechanism had functioned successfully during the recent MSCI rebalancing exercise, which had received positive feedback from global participants. Pandey emphasized that the introduction of such sessions is a standard evolution in global markets, including those in the United States, Japan, and Hong Kong, where liquidity challenges were also observed during the initial rollout phases.

Despite the commitment to retain the session, the regulator is actively reviewing the methodology for determining settlement prices for futures and options contracts. Pandey acknowledged that a specific segment of the market has been adversely impacted by the current reliance on the CAS-determined price for derivatives. SEBI is now studying the experiences of other jurisdictions to refine the process and mitigate the sharp, unexpected swings that have characterized recent expiry days.

For professional traders and retail speculators alike, the CAS window has become a source of significant uncertainty. Many market participants have opted to stay on the sidelines during the final minutes of trading, citing a lack of trust in the indicative prices generated during the auction. Derivatives traders reported that numerous strike prices on the Sensex option chain displayed zero prices, a phenomenon that has become increasingly common on weekly expiry days.

Data from the recent session underscored the scale of the speculative activity. The 74,900 Call European (CE) contract saw its volume jump from 11 million to 17.5 million contracts within the 15-minute CAS window, while the 75,000 CE contract experienced a 48 per cent increase in volume. Shai Coelho, founder of the market structure platform Vtrender, observed that these large additions suggest traders are increasingly using far out-of-the-money options to hedge against the settlement uncertainty created during the auction. He noted that the resulting price spikes often lead to losses for both call and put buyers, as the indicative prints do not always reflect a fundamental repricing of the underlying assets.

Market sentiment remains divided, with some traders expressing frustration over the perceived impact on liquidity and trading viability. Alok Dharia, a derivatives trader at OptionSmart, stated, "We just discovered that Nifty's closing price should be at a level where it never traded all day. All these exchange glitches on options are another way to shut down trading in futures and options. Today, so many strikes on the Sensex option chain had zero prices. This has become a weekly phenomenon." Dharia, like many others, has adopted a policy of avoiding the market during the CAS window entirely.

Critics of the current system argue that the volatility is discouraging participation in the derivatives market. Some traders have drawn parallels between the impact of the Securities Transaction Tax (STT) and the current challenges posed by the CAS, suggesting that the regulatory changes are collectively making the options market less accessible. SEBI has indicated that it is monitoring the situation closely and has been gathering feedback from a wide range of stakeholders, including stock exchanges, brokers, mutual funds, and foreign portfolio investors, to inform its future adjustments.

Beyond the immediate concerns regarding the CAS, SEBI is moving forward with plans to enhance its market surveillance capabilities through the use of artificial intelligence. The regulator is currently implementing an AI supervisory toolkit developed by the International Organization of Securities Commissions (IOSCO). This framework is designed to help regulated entities manage risks associated with AI deployment and establish robust governance standards.

Chairman Pandey highlighted that the goal of these technological initiatives is to shift the regulator from periodic, on-site monitoring to proactive, near real-time, off-site supervision. He stated, "AI can help regulators. We are using certain AI tools, they can help us see risks earlier, but they should inform regulatory judgment, not replace it." As financial firms continue to integrate AI into their trading and risk management operations, SEBI aims to ensure that its oversight mechanisms evolve to address the resulting operational and supervisory challenges.

SEBI is currently in the process of reviewing the specific methodology for derivatives settlement prices to address the concerns raised by market participants. The regulator has not provided a definitive timeline for these changes, but it continues to engage with industry associations and exchanges to ensure that the CAS mechanism eventually achieves the intended market stability without causing excessive volatility on expiry days.