India's new closing-auction system was meant to improve end-of-day prices. In the options market, however, the mechanism is producing extreme swings that are creating and wiping out gains in minutes.
The first monthly expiry at the BSE Ltd. under the new system on Thursday showed how wild the swings can get. A 64,000-rupee put option tied to a bank index was trading at just 1.70 rupees (1.78 US cents) at the start of the auction. Within minutes, it shot up to 68.55 rupees — a jump of nearly 4,000% — before crashing back to zero. The entire move took 15 minutes.
“This is effectively compressing an entire trading session's worth of risk into a few minutes,” said Maurya Ghelani, a derivatives strategist at Kai Securities in Mumbai. “If you are positioned on the wrong side, there may be almost no time to react.”
BSE Bank Index Option Swings Wildly During Closing Auction
Photo Credit: Bloomberg
Thursday's gyrations came amid thinner liquidity at the BSE. The National Stock Exchange of India Ltd., the nation's biggest bourse, also saw sharp moves during its monthly expiry on Tuesday, though the swings were muted relative to those at its smaller rival.
BSE recorded about 4.46 billion rupees ($46.7 million) of closing-auction turnover on Thursday, markedly lower than NSE's 13.77 billion rupees on Tuesday. That shallow pool of orders can amplify price moves when large trades hit the auction.
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The sharp volatility stems from a mismatch in how the cash equities and options markets close. Stocks that have derivatives tied to them get their final prices via an auction, but options keep trading while the auction process is still underway.
Since some expiring options trade at almost no value, even a small move in the underlying index can turn a worthless contract into a big winner — and then worthless again minutes later.
Sensex's 75,000 Put Soars 4,800% During Stock Auction
Photo Credit: Bloomberg
Thursday showed how extreme that risk can become. During the 20-minute auction window, the Sensex plunged to 74,983.19, almost 3% below its 77,182.91 level when the continuous trading session ended at 3:15 p.m. It later pared back some losses to close 0.7% lower.
The banking index also saw a rapid fall in the period, with the BSE Bankex at one point indicating a drop of 3.3% before partially recovering to close 1.7% lower.
For options traders, the consequences can be brutal. Buy at the right moment and you can make many times your money. If you chase the move a few seconds late, you can lose it all.
“The numbers on the screen can look like a lottery ticket,” said Ponmudi R, chief executive at local brokerage Enrich Money.
“The problem is that by the time you realize you've won, the ticket can already be worthless.”
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