U-turn from regulator may be new lifeline to Indian derivatives

That’s the initial takeaway from market players after the Securities and Exchange Board of India said late Thursday that derivative settlements on expiration days would use the volume-weighted average prices of underlying stocks during the final 30-minutes of continuous trading. The move reverses a key feature of the closing auction session introduced on Aug. 3, which led to wild swings in the reference price and plunged the market into chaos.

“Participants going ahead will have greater clarity and predictability around expiry settlement prices,” said Dhiraj Relli, managing director of HDFC Securities Ltd. “This should help restore trader confidence, reduce uncertainty-driven changes in trading behavior and potentially bring derivatives volumes closer to pre-CAS levels over time.”

The reversal could provide a much-needed boost to a market grappling with regulatory curbs aimed at reining in speculative trading. In the month the auction system was introduced, the average daily turnover in equity derivatives fell to an 18-month low on the National Stock Exchange of India Ltd., the nation’s leading bourse, and by one-third on smaller BSE Ltd., before a slight rebound in September.

The latest change should reduce volatility on expiration days, potentially benefiting brokers whose order volumes remain below pre-auction levels, Jefferies Financial Group Inc. analysts said in a report on Friday. The brokerage maintained its buy rating on Billionbrains Garage Ventures Ltd., the operator of India’s largest retail brokerage, Groww.

A more predictable settlement mechanism could encourage traders to resume strategies disrupted by the CAS system. Proprietary trading desks may find it easier to manage expiry risk, while a recovery in activity could lift transaction revenue for brokers and exchanges. Arbitrageurs may also benefit as a return to the previous methodology could make hedging and arbitrage strategies easier to execute, particularly for traders managing large positions across cash equities and derivatives.

“Lower liquidity in the CAS was responsible for participants with relatively smaller book sizes being able to influence closing prices, especially in thinly traded instruments,” said Eshaan Lazarus, founder and chief executive officer of broker 021 Trade. “Reverting to the earlier VWAP system will reduce the scope for such swings, making the process more predictable and potentially bringing back traders who stayed away due to concerns of unfair settlement prices.”