Closing auction scrutiny deepens as wild Sensex swing worries traders

India's benchmark BSE Sensex experienced a sharp 3% plunge during a 20-minute closing auction on Thursday, sparking concerns over thin liquidity and potential manipulation. The index, which tracks the performance of 30 major stocks, briefly dropped to 74,983.19 points, down 2.9% from its end-of-day level, before recovering most of its losses to close 0.7% lower for the day.

Sunil D Pachisia, a vice president at Pratibhuti Viniyog Ltd, noted that such volatility makes it increasingly difficult for investors to gauge market movements. The "closing auction" mechanism, introduced earlier this month, has faced criticism due to unexplained swings in the index during closing sessions, prompting an investigation by the market regulator over alleged manipulation.

Since its implementation, the system has been designed to align India's markets with global standards and curb rigging. However, the BSE did not immediately respond to queries regarding potential changes to the mechanism. The main cause of Thursday's drop was an index-heavyweight stock whose orders were placed at the 3% lower limit during the auction.

Derivatives linked to the stock saw significant fluctuations, with put options for the index expiring on August 27 soaring by 4,800% before reversing by close of trading. The Securities and Exchange Board of India (SEBI) has not yet decided to modify the system, stating that brokers and stakeholders will work to increase participation.

The rapid price movements triggered concerns among traders and investors, with other indices, such as the BSE Bankex, also experiencing sharp declines during the auction window. Volatility in the market rose as a gauge of 30-day ahead volatility based on option prices for Indian stocks increased by 4.8%, the highest in over a month.

Market participants are now focusing on the potential impact of MSCI Inc's month-end index rebalance on Monday, when passive and exchange-traded funds tracking MSCI benchmarks will need to adjust their portfolios to reflect the new composition and weights. Traders are advised to avoid taking naked positions in derivatives during the auction window due to thin liquidity concerns.