The Securities and Exchange Board of India (Sebi) has temporarily allowed arbitrage funds to carry unhedged positions of up to 1% of assets under management (AUM) to improve participation in the closing auction session (CAS), according to two officials privy to the development.
“Sebi has temporarily allowed arbitrage funds to have 1% of their AUM unhedged so that they can participate in CAS. This will help bring more liquidity to the closing auction session,” one of these officials said on the condition of anonymity.
Execution hurdles
Previously, the closing price was calculated using a stock’s or index’s 30-minute volume-weighted average price (VWAP). Under the auction system launched on 3 August, the closing price is established as the single price at which the highest volume of pooled orders are executed between 3:20 pm and 3:30 pm. These auction orders are placed within a plus-or-minus 3% range of a volume-weighted reference price calculated during the 3 pm to 3:15 pm period.
This means the continuous cash market trading session ends 15 minutes earlier, at 3:15pm, while derivatives trading continues until 3:40 pm. The timing mismatch makes it difficult for arbitrageurs to simultaneously execute the cash and futures legs of a trade. In a reverse arbitrage, the trader similarly needs to buy futures and sell cash at the same time.
The auction takes place between 3:15 pm and 3:30 pm, and the final closing price for stocks and indices is published at 3:35 pm. Futures and options positions are then settled using this price.
CAS has struggled to attract sustained participation since its launch. NSE data shows that between the 3 August debut and 15 September, closing auction trading volumes grew 21.6% to 31.5 million trades, while transaction value rose 37.2% to ₹1,751.46 crore.
However, participation remained weak through most of August. Trade volumes during the closing session fell 24.3% from 25.8 million on 3 August to 19.6 million on 28 August, while transaction value declined 26% from ₹1,276.4 to ₹944.94 crore. Participation recovered towards the end of the month following the MSCI index rebalancing on 31 August.
Broader review underway
Sebi’s latest move coincides with a broader review of CAS and its impact on derivatives settlement during expiry days. On 12 September, the regulator proposed changes to the settlement methodology following market pushback over abrupt price swings and expiry-day volatility.
Under one proposal, expiry-day settlement prices for stock and index derivatives would be determined via a blended VWAP approach, combining trades from the continuous session's final 30 minutes with those from the last 10 minutes of CAS. Alternatively, Sebi suggested temporarily retaining the existing model, basing settlement solely on the final 30 minutes of continuous trading, before considering a transition to the blended formula after monitoring CAS for at least a year.
The regulator has also proposed two alternatives for market timings. Under the first, the continuous trading session for stocks covered by CAS would continue until 3:30 pm, followed by the auction from about 3:30 pm to 3:40 pm, while derivatives trading would continue until 3:45 pm. Under the second, the existing 3:15 pm cutoff for continuous trading would remain, with CAS running until 3:25 pm and derivatives trading ending at 3:30 pm.