Starting August 3, Indian stock exchanges are implementing a new Closing Auction Session (CAS) for stocks in the futures and options (F&O) segment. This 20-minute call auction, held between 3:15 pm and 3:35 pm, will replace the previous volume-weighted average price (VWAP) mechanism, which was based on the last 30 minutes of trading. The primary goal of CAS is to strengthen price discovery, reduce the risk of end-of-day price manipulation, and ensure more accurate benchmark prices for indices, derivative settlements, and mutual fund Net Asset Values (NAVs).
The new system is expected to significantly affect cash-futures arbitrage strategies. Traders who simultaneously take opposite positions in cash and futures markets to profit from small price differences may find it challenging to hedge their futures positions with certainty, as the final cash market execution price will only be known after the auction. Hedge fund managers, such as Mayank Bansal, anticipate minor volatility in end-of-day NAVs for arbitrage funds due to different closing practices for cash and future legs, though long-term returns are projected to remain stable. Intraday traders, particularly those close to expiry, may choose to square off positions before 3:15 pm due to uncertainty surrounding the auction price.
Brokers are also bracing for impacts, with some fearing a temporary decline in trading volumes, especially on expiry days. Nithin Kamath, co-founder of Zerodha, estimates that brokerage income could see a reduction of 1-5%. This is largely because the closing auction replaces continuous trading in the final 15 minutes for F&O stocks, which could curb high-frequency and liquidity-providing trades. The new framework will also mean different closing times across market segments: continuous trading for F&O stocks ends at 3:15 pm, non-F&O stocks at 3:30 pm, and futures and options trading continues until 3:40 pm.
The CAS is designed to address issues such as large orders influencing closing prices and tracking errors for passive funds. Nithin Kamath noted that large orders placed in the final minutes previously could disproportionately influence stock and index prices. By pooling all orders and matching them at a single equilibrium price, CAS makes it harder to manipulate closing prices. This also benefits index funds and ETFs by providing a more robust and tamper-resistant reference price, reducing the scope for "marking the close" and protecting retail and passive investors from mispriced settlements.
