The Securities and Exchange Board of India is considering changes to the settlement mechanism for derivatives following concerns over market volatility during the newly introduced Closing Auction Session.
The regulator’s review focuses on one of the most important links between India’s cash and derivatives markets: the price used to settle futures and options contracts at expiry.
The Closing Auction Session, introduced from August 3, was designed to improve closing-price discovery in the equity cash market. Under the earlier system, the closing price was primarily determined using the volume-weighted average price of trades executed during the last 30 minutes of continuous trading. SEBI’s new system introduced an auction-based process intended to aggregate liquidity and produce a more transparent closing price.
While the objective was to strengthen market efficiency, the implementation created challenges for derivatives trading, particularly on expiry days. The cash market’s closing auction and the derivatives market’s trading schedule did not fully align, creating a period in which traders could face uncertainty about the underlying price used for settlement.
This became particularly significant because derivatives contracts can react rapidly to changes in the underlying security or index. On expiry days, a movement in the final settlement price can substantially affect the value of options and futures positions.
SEBI said it had received feedback from various market participants after observing the initial functioning of CAS. On September 3, the regulator announced that it would review the methodology used for determining settlement prices of derivative contracts in light of the CAS rollout.
The latest consultation paper goes further by outlining two possible approaches.
Under the first approach, SEBI is considering a blended volume-weighted average price. This would combine trading information from the final 30 minutes of continuous trading with trades conducted during the Closing Auction Session. The objective would be to create a settlement price that reflects both regular trading activity and the auction process.
The second approach would rely on the final 30 minutes of continuous trading without incorporating the CAS price into derivatives expiry settlement. This could serve as an interim solution while the market adjusts to the new closing-auction framework.
The review is significant because derivatives are a major component of India’s financial markets. Futures and options are used by institutional investors, traders and other participants for hedging, portfolio management and speculation.
A settlement mechanism needs to be predictable because traders build positions based on the expectation that the final settlement price will be determined according to clearly defined rules. Any uncertainty around the settlement methodology can affect trading strategies and risk management.
SEBI is therefore examining not only settlement prices but also the broader functioning of the closing period. It has proposed changes related to the display of indicative prices, treatment of orders and the duration of the post-auction period.
The regulator is considering stopping the display of indicative index closing values during CAS. Officials believe this could reduce the possibility of traders misinterpreting temporary auction information. However, indicative equilibrium prices for individual stocks may continue to be displayed.
SEBI is also considering a restriction on cancelling limit orders that are placed more than 1% away from the reference price. Such a measure could help reduce unusual order behaviour during the sensitive closing period.
The proposals are currently not final. SEBI has invited stakeholders to submit comments before October 3. Feedback from exchanges, brokers, institutional investors, trading firms and other market participants will likely influence the final framework.
The review shows that SEBI is attempting to preserve the core objective of CAS while addressing practical problems that emerged after its implementation.
For investors, the key issue will be whether the final settlement system can provide both accurate price discovery and stability. For the regulator, the task is to ensure that the closing mechanism strengthens India’s market infrastructure without unintentionally increasing expiry-day risks.