New system to determine closing share prices off to a rocky start

The new closing auction mechanism for F&O stocks led to an unusually wide gap between Sensex and Nifty, with market participants citing auction dynamics and liquidity

The new closing auction session (CAS) for determining the closing prices of stocks in the futures and options (F&O) segment had a rocky start on Monday, with the benchmark Sensex and Nifty ending the session with a 0.9 percentage point, or pp — about 91 basis points (bps) — divergence, leaving the Street bewildered.

 

This was the second-biggest closing divergence between the two leading indices after the 105-bp spread recorded on March 26, 2020, according to data analysed by the Business Standard Research Bureau since January 2010, a period of more than 16 years.

 

“The sharp divergence between the Sensex and Nifty at Monday’s close appears to have been driven by the new closing auction mechanism rather than any manipulation. Under the revised system, orders could be placed within a 3 per cent price band, and on the first day, some participants may have submitted buy orders above the prevailing market price in heavily weighted Nifty stocks. Even a 1-1.5 per cent higher auction price in large index constituents can materially lift the Nifty’s closing level,” said Prakarsh Gagdani, founder of Soaring Peaks Capital.

 

Gagdani added that the Nifty saw a sharper spike because the National Stock Exchange (NSE) has significantly greater cash-market liquidity and attracts a larger share of institutional and mutual fund orders.

 

“As a result, concentrated auction activity in high-weighted NSE stocks had a much greater impact on the Nifty than comparable trading had on the Sensex. Earlier, when the closing price was based on the volume-weighted average of the final 30 minutes, both indices generally moved in tandem. The new auction-based process created scope for a temporary mismatch, particularly on its first day,” Gagdani said.

 

Turnover during the closing auction stood at ₹1,276.2 crore on the NSE, compared with ₹10.8 crore on the BSE. ICICI Bank, HDFC Bank, Reliance Industries, Infosys, Bharti Airtel, Bajaj Finance, Eternal, Tata Consultancy Services, CG Power and Axis Bank were the most actively traded stocks on the NSE during the auction.

 

These 10 stocks accounted for around 30 per cent of the NSE’s total CAS turnover, highlighting the concentration of auction activity in large and heavily weighted index constituents.

 

The Sensex ended Monday’s session at 78,639, up 544 points, or 0.7 per cent. The Nifty 50, meanwhile, ended at 24,774, up 391 points, or 1.6 per cent.

 

At 3.15 pm, the Nifty was trading at 24,573.35, up 0.78 per cent, but it ended the session with an additional gain of 0.82 pp, taking its total gain for the day to 1.6 per cent.

 

Large divergences between the Nifty and Sensex were, however, more frequent before 2010. Since January 2000, there have been 75 instances in which the single-day closing spread between the two indices exceeded 91.5 bps. The biggest spread was 257 bps on April 25, 2000.

 

Meanwhile, a senior executive at a brokerage credited the sharp spike in the Nifty during the closing auction to a mismatch between buy and sell orders, potentially driven by systematic investment plan (SIP)-related mutual fund (MF) flows.

 

“MFs and other asset managers may have had to execute large purchase orders in Nifty stocks to deploy SIP inflows and minimise tracking error. Since this was the first session under the new closing auction mechanism, many arbitrageurs and liquidity providers may have remained on the sidelines while assessing how the system functioned. This could have resulted in significantly higher buy quantities than the shares available for sale,” the brokerage executive said.

 

A chief investment officer (CIO) at a mid-sized fund house said the sharp swing in the Nifty during the closing auction came as a surprise, although teething issues were not entirely unexpected during such a major operational change. He said share prices were expected to normalise when the market opened on Tuesday.

 

“If today’s closing price does not reflect fair value, the market should correct itself when trading resumes tomorrow. Fresh price discovery at the open will help narrow the gap, and the discrepancy is likely to be adjusted over the course of trading,” he said.

 

He added that the immediate implication for MFs was on net asset value (NAV) calculations.

 

“Funds have to compute NAV using the prescribed valuation methodology and cannot make their own judgement on what constitutes the fair closing price. The valuation process is automated and generally relies on the closing price from the exchange with higher trading volumes, which, in most cases, is the NSE,” the CIO said.

 

Another CIO said the implications would have been greater had it been an expiry day for F&O stocks.

 

“Had this happened on an expiry day, it could have resulted in significant gains for some participants and equally large losses for others, as settlement values would have been affected. Introducing the mechanism on a non-expiry day has limited the immediate fallout,” he said. Nifty derivatives contracts expire every Tuesday.

 

The NSE did not respond to a query about the sharp spike in the Nifty on Monday.

 

The CAS is a new mechanism for determining the closing prices of stocks in the F&O segment. The price-discovery mechanism does not apply to stocks outside the F&O segment.

 

Instead of calculating the closing price using the volume-weighted average price of trades during the last 30 minutes of the regular session, exchanges now collect buy and sell orders after regular trading ends and match them at a single equilibrium price at which the maximum number of shares can be traded. This becomes the stock’s official closing price.

 

The mechanism is expected to make closing prices more reflective of actual demand and supply, improve price discovery, and curb the impact of large last-minute trades.