SEBI has ended the closing auction system for derivative settlements, returning to the volume-weighted average price (VWAP) method. The decision follows reports of thin liquidity and erratic price swings that dampened trading activity. Investors can now expect more predictable pricing on expiration days, a move likely to encourage higher trading volumes on exchanges like the NSE and BSE.
The Securities and Exchange Board of India (SEBI) has officially changed how derivatives are settled on expiration days. Starting immediately, the regulator has scrapped the closing auction mechanism that was introduced on August 3 and has returned to the volume-weighted average price (VWAP) method. Under this system, settlement prices will be determined by the average price of trades executed during the final 30 minutes of continuous trading.
This decision marks a return to a more familiar process for market participants. The auction system, while intended to manage volatility, resulted in unexpected price fluctuations that made it difficult for traders to execute orders efficiently. These erratic price moves created uncertainty, leading many institutional and retail traders to reduce their activity. Consequently, trading volumes across major bourses, including the National Stock Exchange (NSE) and BSE, fell to their lowest levels in 18 months, highlighting the negative impact on overall market liquidity.
For investors and traders, the primary benefit of returning to the VWAP model is predictability. During the auction period, a small number of trades could significantly skew the closing price of a contract, which exposed traders to sudden, unjustified losses or profits. By using the average price over the last 30 minutes, the impact of single large or small orders is smoothed out, creating a more stable benchmark for settlement. This stability is expected to make expiration days less stressful for those holding open positions.
This change is also a positive development for brokerage houses and exchanges. Lower liquidity directly hurts transaction-based revenue, which is a key income stream for brokers and exchanges. As the market environment becomes more stable and predictable, brokerages anticipate a recovery in trading volumes. Proprietary trading desks and arbitrageurs, who had been cautious due to the risk of skewed closing prices in less active contracts, may also re-enter the market more confidently.
While the regulator remains committed to preventing market manipulation and excessive speculation, this adjustment is viewed as a pragmatic move to fix issues that hampered normal trading operations. Investors should watch the upcoming expiration cycles to see if liquidity levels improve and if trading volumes rebound to previous averages. The success of this move will be measured by whether the market can maintain price stability without the friction caused by the previous auction system.