Sensex weekly expiry to debut under Closing Auction System amid volatility concerns

Sensex derivatives weekly expiry on Thursday will be the first under India's new Closing Auction System, raising concerns over volatility due to lower liquidity in the BSE cash market. Traders remain cautious after sharp movements during Nifty's recent expiry under the mechanism

Mumbai: The weekly expiry of headline index Sensex derivatives on Thursday will be the first to take place under India’s new Closing Auction System (CAS) as market participants brace for higher volatility amid concerns over relatively thin liquidity in the BSE cash market.

Traders are approaching the session cautiously after the Nifty’s Tuesday expiry when the benchmark index surged more than 150 points during the closing auction that triggered sharp moves in derivatives and caught several market participants off guard.

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According to many analysts, concerns are more pronounced for Sensex because the cash market underlying the index sees significantly lower participation during the auction window than the NSE which raised the possibility that the final settlement price could be more susceptible to large trades.

The effectiveness of the system depends on broad market participation, they added. The market experts further noted that auction volumes on the NSE have improved in recent sessions, with the gap between Nifty spot and futures prices narrowing, participation in the Sensex closing auction remains comparatively limited.

Reflecting the uncertainty, implied volatility on Sensex call options rose sharply ahead of Thursday’s expiry which indicated that traders are pricing in a higher probability of significant late-session price swings.

In addition, under the Closing Auction System, stock exchanges collect buy and sell orders during a designated auction window and determine a single equilibrium price at which the maximum number of orders can be matched.

However, the mechanism was rolled out to improve price discovery at market close. Meanwhile, some participants warned that low liquidity could make the settlement price easier to influence if a few heavyweight stocks witness aggressive buying or selling during the auction.

Even relatively small price moves in index heavyweights could have a disproportionate impact on the Sensex closing level and, consequently, on options settlement, according to them.

On the other hand, as per some analysts, such concerns may be overstated, saying that traders are likely to reduce exposure following the volatility witnessed during Tuesday’s Nifty expiry rather than take aggressive positions ahead of the first Sensex expiry under the new mechanism.

Despite near-term concerns, analysts broadly expect any volatility arising from the Closing Auction System to be temporary as market participation improves and price discovery becomes more efficient over time. Additionally, BSE has issued an advisory for investors and traders to familiarise themselves with the CAS.