The Securities and Exchange Board of India’s decision to introduce call auctions to determine opening stock prices is a step in the right direction. The Indian markets would benefit immensely, as call auctions would reduce volatility when the markets open for trading. Currently they witness wild price swings at start of trading— especially when major overnight news has to be priced in. The Indian markets have in the past moved by more than 10% at the start, leading to margin calls and its related problems for brokers and the markets.
Call auctions are a tailor-made solution for the above problem. When traders submit their orders in the pre-open call auction session, these orders aren’t immediately matched with other orders, as they are in the normal market session. Instead, all orders are aggregated and at the end of the call auction session, a clearing price is determined, which is the price at which the maximum volume can be executed. Orders that can be matched at this price and market orders are then executed, to the extent possible. This price then becomes the opening price for the stock. Traders can submit market orders in the call auction session, and can breathe easy that the order would be executed at a relatively fair price, compared with the high uncertainty of submitting a market order in a volatile market.
Call auctions can be even used to determine closing prices, as this will aid traders who arbitrage between the cash and derivative markets. Some market experts and researchers have suggested that periodic call auctions could be the solution for trading illiquid securities, where there isn’t enough trading interest to justify continuous trading through the day. Besides, 13th Finance Commission chairman Vijay Kelkar has mooted the idea of the government using the pre-open call auction sessions on stock exchanges to divest its shareholding in listed companies to contain the impact of its share sales on the market price. They can also be used to determine the new “equilibrium price” for a stock or the whole market after an extreme news event.
There are myriad benefits for the Indian markets by adopting call auctions, and their use must be extended after testing success in determining opening prices of stocks and reducing volatility when the markets open.
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