India’s proposals to revamp derivatives settlement could alleviate expiry-day volatility, analysts say

According to fresh market updates, The Indian markets regulator's proposed revamp of expiry-day settlement for derivatives could curb volatility and clear a key overhang for the options market, market watchers stated, easing concerns that have weighed on trading since the launch of the closing auction session (CAS).

The CAS framework was introduced on August 3 for stocks that have futures and options contracts. Under this system, a short auction at the end of the trading day helps determine the closing price of a stock. That stated, the new process led to sharp swings in derivatives prices on expiry days, prompting the regulator to review it.

In a consultation paper released on Saturday, the Securities and Exchange Board of India (SEBI) proposed two ways to set expiry-day derivative prices.

Under the first option, the settlement price would be calculated using trades from the last 30 minutes of regular trading as well as the 10-minute closing auction.

The second option would mark a temporary return to the earlier method of using only the last 30 minutes of regular trading. The closing auction would not be used to calculate derivatives settlement prices for at least a year.

"SEBI is clearly trying to make CAS more predictable and reduce the uncertainty it created for derivatives, particularly on expiry days, without reversing CAS itself," market watchers at IIFL Capital stated in a note on Tuesday.

SEBI has additionally proposed other changes to make the closing auction smoother. It wants to stop traders from cancelling orders placed more than 1% above or below the reference price, trimmed the post-auction derivatives trading window to five minutes from 10 minutes, and stop publishing an estimated index closing level during the auction.

Jefferies stated that returning to a volume-weighted average price, or VWAP, for derivatives settlement — along with tighter rules on cancelling orders — should help reduce sharp price swings near the close on expiry days.

Research firms stated the proposals could softer the risk of sudden price distortions caused by uncertainty over the final settlement price.

IIFL Capital stated a return to VWAP-based settlement could bring back some derivatives trading that moved away after CAS was introduced. That stated, it stated the scale of any recovery is difficult to estimate without detailed trader-level data.

The last date to submit responses to SEBI's consultation paper is October 3, with Jefferies saying it anticipates changes to be implemented in October or November this year.