Distortions are inevitable: Nithin Kamath explains why new closing auction is causing wild moves in Indian stocks

Zerodha co-founder Nithin Kamath has pointed out that the recent sharp price swings seen during the newly introduced Closing Auction Session are not due to a flawed mechanism, but rather a reflection of deep-rooted structural limitations in Indian equity markets. In a post on X, Kamath noted that while the closing auction itself is a standard global practice, the volatility it has triggered highlights clear imbalances in how local markets function.

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The debate comes as SEBI's overhaul of the closing mechanism for F&O stocks has left options traders and algorithmic desks struggling with unpredictable late-day swings. Replacing the traditional 30-minute volume-weighted average price (VWAP) method, the new 20-minute auction session pools orders between 3:15 pm and 3:35 pm to discover a single official closing price. However, sharp swings near the close have triggered heavy losses for intraday strategies, leading to growing calls from the trading community for changes or a temporary rollback of the system.


Kamath explained that closing auctions work effectively in major global financial centers because passive index funds and benchmark-tracking institutions rely on them to execute large trades cleanly. Instead of calculating closing prices based on a 30-minute average, the auction brings late-day orders together to discover a single final price without causing sudden slippage.

However, Kamath said the price dislocations seen over recent days show that India lacks the deep two-sided liquidity and broad participant ecosystem needed for these auctions to run smoothly.
In mature markets, whenever prices diverge between cash, futures, or ETFs, arbitrageurs step in to buy the cheaper asset and sell the pricier one, quickly erasing the gap. In India, that ability to arbitrage is severely constrained by market design and high transaction friction.

"For one, it is impossible to express a short view in the cash market," Kamath said. He noted that while a Securities Lending and Borrowing mechanism exists, it remains shallow and hard to use. Without an easy way to borrow and short stocks, the cash market develops a natural upward bias.

At the same time, tax changes have made futures trading far costlier than options, steering liquidity away from the very instruments needed for effective arbitrage. Following the increase in Securities Transaction Tax on futures to 0.05 percent of total contract value, trading futures became much more expensive than trading options, where tax is charged only on the premium.

"Once you add STT, exchange charges, spreads, and impact costs, the trading opportunity has to be quite attractive before a futures arbitrage trade is worth doing," Kamath said.
Although India has over 13 crore registered investor accounts, Kamath pointed out that only 20 to 30 lakh investors trade actively on any given day, leaving a thin pool of traders to absorb sudden institutional flows during the closing bell.

Kamath stressed that solving the underlying issue will require deeper market reforms, such as making stock shorting easier, reducing tax distortions between trading instruments, and actively encouraging genuine market-making.