Closing Auction Session: Why the system expected to reduce volatility is still seeing occasional wild swings

The closing auction session (CAS) was introduced earlier this month in a bid to bring in more efficiency in discovery of closing prices on the share market. However, it continues to see volatile trading, and sharp and sudden swings. Experts say CAS should lead to more transparency over time, but feel its still a work in progress and call for the regulator to closely examine certain trades.

Thursday’s monthly derivatives expiry, the first since the CAS was introduced, saw the BSE Sensex move over 2,000 points with a matter of minutes. On the one hand traders have been complaining against the system, while on the other, regulatory surveillance has also been stepped up to check any manipulation.

CAS was introduced on August 3. It’s a new method to determine closing stock prices and the hope was it would reduce volatility and any manipulation. It replaced the earlier Volume Weighted Average Price System (VWAP).

CAS begins at 3.15 pm and ends at 3.35 pm. The initial five minutes are considered as a transition period to calculate the reference price and the transition to the auction. Continuous trading ends in the stock market at 3.15 pm. The official closing price is then determined by pulling buy and sell orders and matching trades at a common price.

CAS may be new to India, it has been prevalent in many major global markets from Europe to the USA. However, traders have often pointed to noticeable gaps in the pre-auction price levels and final settlements.

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Trivesh D, the chief operating officer of trading platform Tradejini agrees that CAS is a step towards making the closing price more transparent. At the same time, he pointed that the first few expiry sessions did raise some legitimate questions around liquidity and price discovery. While the unusual moves cannot automatically be attributed to CAS, they warrant closer observation, he told Business Today.

For instance, he pointed that Dixon Technologies’ 15,000 call option (CE) saw an extreme move from Rs 2.65 to Rs 104.90 before closing at Rs 0.05 on August 25. Call option is a type of futures contract that allows a buyer to purchase an asset at a set price within a specified time. But there is no obligation on the buyer to execute it. Trivesh pointed to similar volatility in Sensex call and put options on the monthly expiry day on August 27.

“Movements of this magnitude and speed are certainly unusual and warrant closer examination,” he said.

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The market regulator is watching things closely. On August 19, Securities and Exchange Board of India barred two entities – Copthall Mauritius Investment and Mansi Share and Stock Broking from accessing the securities market and also ordered them to deposit Rs 3.68 crore combined on allegations of manipulative trading during a Sensex CAS on August 13.

The regulator had observed three significant spikes in the Sensex indicative equilibrium price during CAS. While, Copthall allegedly gave aggressive buy orders, Mansi gave aggressive sell orders.

“If two entities can have a significant impact on the index during a thin auction window, the question is whether this creates a better window for price discovery or also a window for price manipulation,” wonders Trivesh.

Hariselvan Radhakrishnan, founder and CEO of HST Wealth, pointed out that the divergence between Sensex and Nifty in the initial days perhaps reflected the differences in market liquidity. Institutional order flows were concentrated more in Nifty than compared with the Sensex, he said.

Issues have also been raised by traders around thin trading volumes and that is perhaps a reason why there are wild swings in some stock prices during CAS.

“The BSE cash market volumes are significantly lower than those on the NSE. Since the CAS relies on orders and trading activity on the respective exchange, lower participation and liquidity can potentially make the closing price more sensitive to individual orders and sudden changes in demand and supply,” said Trivesh.

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Experts, however, remain hopeful that CAS is a work in progress and the various issues should get addressed over time.

“CAS is a very good system, although there are some flaws” said Radhakrishnan, who particularly feels there is a need for more transparency and disclosure of order flows during CAS.

He says any new system implemented needs time for everyone to understand and the issues should get ironed out in few months.

“Its barely been around a month, around 20 trading days. It’s a very small period to calibrate the market. Everyone still is learning this system. So, in 2-3 months, the volatility should reduce,” believes Radhakrishnan.

Trivesh also feels its still early days and CAS could potentially become more efficient as participation builds over time.

"Larger and more diverse participation generally makes it harder for any single participant to influence prices. As participation increases and liquidity deepens, we may see the mechanism normalise," he noted.

Broking platforms on their part have been taking steps towards simplifying CAS for traders. Tradejini, for instance, has a dedicated CAS Indicator, along with the indicative close rpice, reference price and total imbalance as well as a dedicated CAS dashboard on its platform.

A few brokers like Angel One have also quickly moved to implement the new order queuing mechanism, which will enable customers to place and queue orders during the transition window from 3.15 pm to 3.20 pm. Angel has also introduced other things like indicative closing price, volume and quantity information to provide more visibility to its clients.

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