India’s new stock auction system faces first monthly expiry test

Indian traders are preparing for their inaugural monthly derivatives expiry, which will rely on auction-based end-of-day stock prices. This marks a critical test for a system that has faced criticism over price volatility and manipulation allegations. The new process has been implemented alongside regular sessions and weekly expiries since its inception on August 3.

Tuesday's expiry will encompass a wider range of derivative instruments, including physically settled single-stock options, which will be priced based on the auction-generated closing prices. Quantitative analyst Kruti Shah notes that a monthly expiry introduces greater significance to the closing price, especially for stock futures and options.

The system's introduction has been met with limited participation from proprietary trading firms and high-frequency traders, who have avoided the auctions, leading to lower trading volumes. Additionally, arbitrageurs have encountered fewer profitable opportunities due to a reduced late-session window for trading stocks and derivatives simultaneously.

Regulatory bodies have shown increased scrutiny towards the mechanism, with the Securities and Exchange Board of India (SEBI) recently suspending two firms, including a JPMorgan Chase unit, for alleged price manipulation during the auction. Tuesday's monthly expiry carries an additional risk as single-stock options will be affected.

A significant stock price movement during the auction can transform an option that was expected to expire worthless into a profitable one. These contracts are physically settled at expiry, meaning investors might be required to deliver shares or funds, potentially altering their positions drastically. SEBI has cautioned about this risk and has extended trading opportunities beyond the auction, providing investors with more time to adjust their positions following the final auction-closing price and delivery obligations.