Mutual Funds Seek Fair-Value Pricing For Equity Futures To Curb Arbitrage Fund NAV Swings

The mutual fund sector has proposed revisions to the valuation of equity futures at market closing in order to lessen the volatile fluctuations in the net asset values (NAVs) of arbitrage funds, according to a Moneycontrol report. This suggestion aims to synchronize the closing systems of both cash and derivatives markets by estimating a theoretical or fair-value price for futures, based on the last closing price of the cash market determined during the Closing Auction Session (CAS) and the current cash-futures spread.

Arbitrage funds, which currently manage approximately ₹3.5 lakh crore, typically buy equities in the cash market while simultaneously selling their futures contracts. Ideally, the movements in these two positions should offset each other. However, the implementation of the CAS has introduced a timing and pricing discrepancy. Now, cash-market prices are determined via the closing auction, while equity futures continue trading after the close and employ a different method to calculate their closing value.

This can cause the cash and futures components of an arbitrage position to be valued differently, even when the economic relationship between the two remains stable. As a result, arbitrage funds may show significant daily NAV increases or decreases, despite minimal changes in the underlying arbitrage position.

The industry has suggested calculating the futures closing price using the formula: CAS cash closing price + predetermined cash-futures spread. This spread would be calculated from the relationship between the cash-market weighted average price (VWAP) and the corresponding futures price over a defined period before the close. The regulator and exchanges would need to determine the precise calculation method and time frame.

Implementing this system could yield more stable NAVs and ensure fairer entry and exit pricing for arbitrage-fund investors. Furthermore, such a change could have broader implications for the derivatives market, potentially reducing the necessity for futures markets to remain open after the cash-market closing. However, any modifications would impact clearing, settlement, margining, and mark-to-market calculations, necessitating revisions to existing frameworks by exchanges and clearing corporations.