Market chaos after CAS: What exactly is Sebi reviewing and will it stop expiry-day wild swings?

Sebi's decision to review the settlement price methodology for derivative contracts after the rollout of the Closing Auction Session may ease the sharp expiry-day swings seen in recent sessions, but analysts say the regulator is unlikely to scrap CAS altogether. The market regulator said on Thursday that it may propose changes in the way settlement prices are determined for derivative contracts, after receiving feedback from market participants on the use of CAS-based closing prices for expiry settlement. A consultation paper is expected in about a week.

CAS was introduced in the equity cash segment from early August this year to determine the closing price of securities. Under Sebi’s framework, the price discovered through CAS also serves as the basis for settlement prices of derivative contracts on expiry.

That linkage has become the main point of concern for traders after sharp last-minute moves in the cash index fed directly into futures and options settlement values.

CAS link under the scanner

Shruti Jain, Chief Strategy Officer at Arihant Capital Markets, said Sebi is reviewing the methodology because CAS has, in some cases, produced sharp late moves that directly affect option and futures settlement prices.

"There is a lot of speculation in the market and Sebi will release a consultation paper by next week for clarity," Jain said.

She said the regulator may not completely remove CAS because the mechanism was introduced after consultations and is meant to improve closing price discovery. The more likely step, according to her, may be to reduce the direct link between the CAS close and derivative settlement.

"My sense is that they’ll not completely remove CAS. They will need to delink the close of derivatives and CAS closing though," Jain said.

She said one possible solution could be to close the CAS window after derivatives trading closes. That would reduce the risk of sudden auction-driven moves feeding into expiry settlement prices.

"A revised settlement framework can smartly reduce the severity of expiry-day swings that come from CAS price discovery, but it won’t calm expiry days in all scenarios," she said.

Why traders are worried

The concern became sharper after the September 3 expiry, when the Sensex saw a sudden fall during the closing auction window. The index moved from around 76,510 at 3:17 pm to about 74,373 at 3:20 pm, triggering a surge in put options.

Some Sensex put contracts jumped sharply in minutes. The 76,600 put rose from Rs 102 to Rs 446, while the 76,400 put moved from Rs 45 to Rs 246. Traders said such moves showed how CAS-driven price discovery can create outsized impact in near-expiry options.

Ishan Tanna, Senior Associate at Ashika Capital said Sebi is essentially reviewing how the final settlement price of derivatives is calculated on expiry days.

"Since August 3, the cash-market closing price is discovered through a 20-minute Closing Auction Session, replacing the earlier 30-minute VWAP method. That CAS price also feeds into derivatives settlement," Tanna said.

He said the September 3 episode showed the risk clearly, as the Sensex’s indicative price briefly plunged about 2.5%, while some put-option premiums jumped 400-500%, before the index recovered and closed only 0.55% lower.

"Sebi is now considering whether derivatives should continue to use the CAS-derived closing price in its current form," he said.

Also Read: Sebi to review derivatives settlement price methodology after CAS volatility

Review seen positive for market stability

Rahul Sharma, Head of Research at Equity99, said the review is a positive development for derivatives-market stability. "Sebi's proposed review is positive for derivatives-market stability, but the actual impact will depend entirely on the alternative settlement formula," Sharma said.

He said a change in methodology should reduce CAS-driven expiry volatility, though it will not remove the usual swings that come with expiry-day positioning. "Yes, it should reduce the CAS-driven sharp expiry-day swings, but it will not eliminate normal expiry volatility," he said.

Expiry sessions are generally volatile because traders unwind positions, roll over contracts, adjust hedges and respond to high gamma in near-expiry options. The problem with CAS, analysts said, is that a short-lived move in the cash-market closing auction can become mechanically important for derivatives settlement.

Tanna said a revised formula could reduce the transmission of auction volatility into derivatives settlement by making the final price less dependent on a single auction outcome.

"Likely to reduce the extreme, mechanically amplified swings — but not eliminate expiry volatility," he said.

He said the better solution would be to fix the linkage between cash-market closing price and derivatives settlement, rather than remove CAS itself.

Sebi is looking at the issue through the settlement price lens, rather than questioning the full CAS framework. The regulator said a significant area of feedback related to the determination of settlement prices of derivative contracts on expiry based on CAS-determined closing prices.

Sebi also said CAS was introduced after two rounds of public consultation and discussions with stock exchanges, broker associations, institutional investors, market participants and other stakeholders. Since implementation, it has engaged with exchanges, brokers, proprietary traders, software vendors, mutual funds, industry associations and FPIs.

The consultation paper expected next week will be closely tracked by brokers and derivatives traders.

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