The recent changes to the Closing Auction Session (CAS) rules by the Securities and Exchange Board of India (SEBI) are causing some short-term challenges for arbitrage funds. Due to this, investors in this segment need to make changes to their approach and timing to manage volatility, Harsh Kumar, Managing Partner and Co-Founder of Zvest Financial Services, said, sharing a potential playbook for investors.
CAS was introduced from Aug. 3 for stocks with derivative contracts. Under the new system, the cash market moves into an auction session from 3:15 pm to 3:35 pm, while equity derivatives continue to trade until 3:40 pm. This creates a timing mismatch between the cash and futures markets, making it harder for arbitrage funds to capture price differences smoothly.
“Now if you're buying or selling in the cash market, during the auction window, you don't have simultaneous availability of corresponding derivative hedge. And this has added a layer of execution risk in the arbitrage fund,” Kumar explained, while speaking to NDTV Profit.
Still, investors do not need to panic over the situation and only change their playbook, he said. For new or incremental investors, Kumar advised against putting the entire amount into an arbitrage fund on a single day.
Why Investors Should Not Invest In One Go
To understand why timing matters, Kumar explained that these funds buy a stock in the cash market and, at the very same moment, sell the matching futures contract.
Before CAS, both cash and futures traded simultaneously. After Aug. 3, the cash market enters "auction" mode after 3:15 p.m., while the futures continue to trade as usual.
As both segments behave differently, this makes it hard for fund managers to buy and sell at the same time. This is what Kumar called an added "execution risk."
To deal with this, he advised new investors to spread their money across three or four dates in a month. This can help reduce the risk of being affected by a sudden market move on any single day.
“Instead of putting the entire sum of money on a single day, I want to suggest that investors spread it... they can take three-four dates in a month and they could ladder their money on those dates to avoid the risk of losing the returns because of a single day market risk,” he explained.
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He also advised investors to temper their expectations from arbitrage funds. With the introduction of CAS, these funds could see short-term fluctuations in their NAVs, making returns less predictable than before.
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