VWAP-based settlements, tighter bands among Sebi's possible CAS fixes

The Securities and Exchange Board of India (Sebi) may propose changes to the closing auction session (CAS) framework such as an overlapping derivatives trading session, restrictions on late order entry, and settlement based on volume-weighted average price (VWAP) spanning the pre-auction and auction windows, according to a report by HDFC Securities.

In its report on BSE, HDFC Securities has maintained its ‘Add’ rating on the stock, saying the regulatory impact from the new closing auction session (CAS) is behind the exchange and that derivatives volumes are now set for recovery.

The brokerage, however, cut its target price to Rs 3,850 from Rs 3,900 and lowered its FY27 and FY28 earnings estimates by 4 per cent and 2.3 per cent, respectively.

The market regulator last week announced that it will soon come up with a consultation paper on changes to the methodology used for determining settlement prices of derivative contracts, following feedback. The proposals are expected within days.

“Plausible fixes, none of which require rolling CAS back, include tighter auction price bands, an extended or overlapping derivative session, restrictions on late order entry, and settling index derivatives on a VWAP (volume-weighted average price) spanning the pre-auction and auction windows,” notes the report.

The brokerage believes these changes would be volume-accretive.

Citing the example of Hong Kong — which launched a closing auction in 2008 but withdrew it in 2009 after end-of-day price swings and reintroduced it in 2016 with price limits and other changes — the brokerage has highlighted that liquidity will take time and the first few months of the auction look ‘worse than the steady state’.

“Most global markets settle index derivatives on the auction price itself, or on an average that spans the auction, so hedging stays possible right through. India stops cash trading fifteen minutes before the derivative session ends, which leaves a gap nobody can hedge. This is the specific point industry expects the consultation paper to address,” it added.

According to sources, the market regulator may allow index expiry at 3:15 pm based on VWAP and may also propose certain tweaks to the price range.

CAS, which went live on August 3, has triggered a sharp decline in derivatives activity, with BSE’s options premium average daily traded value (ADTV) falling 26 per cent month-on-month to about Rs 187 billion in August.

“CAS was introduced to align India with global closing-price practice and remove the 30-minute VWAP window as a manipulation vector. The design is sound, although the rollout was not, and uncertainty around the expiry-day settlement price has kept option writers on the sidelines,” the report notes.

Industry-wide premium ADTV declined 19 per cent to Rs 610 billion. BSE’s notional ADTV dropped to Rs 153.6 trillion from Rs 232.2 trillion in July.

The report said the disruption was concentrated in derivatives and expiry-day activity rather than reflecting a broader withdrawal of market participation. BSE’s cash ADTV, in fact, increased to about Rs 106 billion in August from Rs 99 billion in July, the report noted.

The brokerage attributed the initial weakness to uncertainty around the auction-determined closing price.

Since cash trading ends at 3:15 pm while index options continue until 3:30 pm, option writers are unable to hedge against a closing price that is not yet known. Thin auction books have further reduced predictability, pushing writers out and compressing expiry-day premiums, the report noted.

Signs of recovery have emerged, with BSE’s premium ADTV rising 18 per cent week-on-week to Rs 228 billion, although it remains about 23 per cent below the first-quarter FY27 level. The brokerage expects BSE’s premium ADTV to rise to Rs 255 billion in FY27 and Rs 315 billion in FY28, with market share reaching 30.7 per cent and 33.7 per cent, respectively.