What Is the Closing Auction Session (CAS) and How Does It Affect Investors?
Capitalmind with Deepak & Shray
Shray Chandra and Deepak Shenoy discuss the implementation of the new Closing Auction Session (CAS) on Indian stock exchanges. They explore
Key takeaways
- The old closing price mechanism relied on a volume-weighted average price (VWAP) of the last 30 minutes, which was susceptible to manipulation via large end-of-day trades.
- The new CAS uses an auction process between 3:15 PM and 3:30 PM to find an equilibrium price based on limit orders.
- A significant issue is that broker terminals often fail to show the full depth of the order book, leaving investors 'running blind' regarding where actual trades are occurring.
- The discussion cites Bharti Airtel as a case study where the closing auction price significantly deviated from the intraday trading range.
- There is currently a disconnect between cash market closing prices and futures prices, creating temporary arbitrage opportunities but also market uncertainty.
Main topics
- Closing Auction Session (CAS) mechanics
- Price discovery and manipulation prevention
- Impact on Mutual Funds and Index Funds
Notable quotes
We're all running blind.
Conclusion
While the CAS is designed for better price discovery, its success depe
Transcript preview
Speaker 2 (0:09) Hello and welcome everyone to the Capital Mind podcast. If you'd like to know more about us, visit capitalmind.in. And if you'd like to invest with us, do visit capitalmindwealth.com. Speaker 1 (0:22) This podcast is for informational purposes only and should not be relied upon as the basis for investment decisions. Clients of Capital Mind may maintain positions in the securities discussed in this podcast. Speaker 2 (0:37) Hi everyone, and welcome to a new episode of the Capital Mind podcast. It's been about two and a half weeks since the new CAS, Closing Auction System, came up to determine closing prices on the stock exchanges, and it's been an eventful few weeks. To understand the CAS better and how it impacts you and your money, we thought we'd bring in Deepak Chinoy for this somewhat technical episode to figure it out. Do listen in. Speaker 2 (1:07) All right, Deepak, so welcome back to the audio version of this podcast. It's been a while since we did this last. It's been an inventful month for stock markets, other than, of course, some signs of life showing up again and things trickling back. We've moved to a new closing price mechanism. It went from the old version, which I'm going to ask you about, to something called CAS, Closing Auction Session. So let's just warm up with this basic question. Why does this CAS exist and what used to happen before? Speaker 3 (1:34) Yeah, I mean, excited. 100th episode of the podcast. And I think we've had this through COVID and a bunch of other things. And now we're doing the audio session section separately again. Coming to the closing auction session, suddenly, or not suddenly, but over a period of time, a discussion has been happening within SEBI that the closing price of all stocks is somehow not determined correctly. Now, when I say correctly, I mean what happens is the volume weighted average price of the last 30 minutes of trade. This is the price at which all mutual funds NAVs are calculated, all index funds are calculated, the NIFTY is calculated and all that stuff. Speaker 2 (2:18) Not just index funds, the indices itself, right? Indices themselves, yeah. Speaker 3 (2:21) So you actually have, since you have such a large differential, such a large set of, you know, things depending on the index, you actually have... I have to have it to be a reliable price. For the most part, it is reliable. Speaker 2 (2:37) Closing prices matter. Closing Speaker 3 (2:39) prices Speaker 2 (2:39) matter. Speaker 3 (2:40) So now, can you perhaps manipulate this? The answer would be if I brought in a lot of volume in the last one minute of the day without anyone knowing about it, the volume weighted average price means whatever price I execute, this very large volume becomes the volume weighted average price because it overshadows all the other volume that's happened in the last 30 minutes. And unfortunately, that might be a determinator of the last price. So if the price was at 100 in the last five, last one minute, I sold, I don't know, a truckload of shares. Then the price could have fallen to 98, a 2 % fall. The stock was at 100 all day. How come the closing price is 98? Because one guy brought in this massive volume and he's like, listen, I had to sell. And there was nobody on the buying side. Well, that's yes, because obviously you didn't pre-announce it and then it's the last minute of trade things will happen. So, well, there has to be a better mechanism for doing this. Then let's, instead of doing this closing price of the last 30 minutes already, can we do an auction session? Speaker 2 (3:45) I'll interrupt here only because I have a question. Why is this a bad system? I understand what you're saying that sure, someone had to come in, but large people always will move markets, right? I mean, the fact that this person showed up at 3.29 means that he or she influenced the closing price of the day. But had they showed up at 10 a.m. or 11 a.m. also, they would have moved the stock with a huge order probably. Yes, Speaker 3 (4:06) but by that time, they had enough time in the rest of the day to chop up that order into small pieces and kind of try to get the whole thing. But the problem, again, for index funds, for instance, they have to. to trade at the closing price of the day. The reason for that is if all day the stock is traded at 100 and they want to sell because the index has changed and they need to buy, sell one stock and buy another stock. They do the sell in the last half an hour of the day. Now they could sell at, I don't know, 99. The price could rise after they sold to 101. The index is calculated according to the closing price, which takes 101 into account, whereas the actual thing that they sold at was 99. So they're complaining, saying, we lost 2 % for what somebody came after us and just moved the market. Can we somehow get the closing price? And how does it work abroad? So the volatility in that window is a little unnecessary. Can we do a better mechanism? It's a little bit like if you go to... A booth when there's nobody. You can go anytime you want. You can book your tickets or whatever it is. But if there are a lot of people there, they organize you into a line so that we know who's come first, who needs to get served first, and so on. Of course, in India, it doesn't mean anything like that. But in most other places, you'd want to do that. Because you want the organization when there is a potentially high, you know, this thing system, we will kind of try to build a different system. Foreign countries have already had it. So the closing auction sessions will basically change the underlying system into something that says, listen, hold on. Why don't you put all your buys and sells in? Let us then determine what the price should be. Speaker 2 (5:59) I remembered one more reason why the old system had issues because our futures and options market was so much bigger than the spot market, right? People were willing to say, you know what? throw 500 crores at this stock, lose 2-3%, but by selling it, I guess, and forcing it down. But on the other side, I'm short on the futures or the options or whatever. And I'll make so much more because I'm making some money on that side. Speaker 3 (6:25) There was a temporary order on James Street that actually talked about how the last minute, last 30 minutes would bring in, say, 500 crores or 1,000 crores into one stock. that stock would move in one direction that would move the nifty itself the nifty is the index on which all these options are traded jane street was also an option trader and they would benefit on the option side but lose on the stock side and you know and Speaker 2 (6:53) they would size the bets appropriately so that In one area, you would lose maybe only 10 crores, but you could hopefully make 100 crores on the other end. On the other side. So Speaker 3 (7:00) there was potential movement happening at that time. And because it was indeterminate in the sense a person coming at 329 could determine the volume. Speaker 1 (7:09) There Speaker 3 (7:09) was this thought that said we need a better system. And maybe we do. And this has vexed a lot of option traders now that we've got a closing auction session. We'll come to that. But it is a different way. And I think in... A lot of ways it's a better way. It's just that it is currently a little raw and it hurts a bunch of people. But it will take some time before it kind of evolves into a system that eventually we will accept as a better system. To give you an example, there was an opening auction session that started in 2009. The open prices were arbitrary. It was the first price of the day, which made no sense at all. So they made this opening auction to make the open better. And it's been going on from 2009 to now, which is about 17 years. And Speaker 2 (7:54) this is the thing that happens between 9 and 9.15. Speaker 3 (7:57) 9 and 9.15. So there's a bunch of things that happen. Five minutes to do this, five minutes to do that and so on. It's a much easier system for someone with a large order in the beginning of the day to do. However, it has not much meaning because no NAV is marked to the open. It's only marked to the close. So there is no downstream impact of the open auction. There was something else that happened, but it's a good thing in general. But now I think they've tried to repeat this in the closing auction session, which is the same time frame. Instead of 9 to 9.15 open session, 3.15 to 3.30 officially is the timing for the closing auction session. Speaker 2 (8:34) Okay, let's dive into it. We've gone through the old system quite a bit. So how will it work? Speaker 3 (8:39) Yeah, so if it's possible for me to manipulate a stock in the closing 30 minutes, We want a system that's better than that. We want a system that's more fair in that sense. Now, gas works in a slightly different way. Let's say all trading stops at 3.15 in the market. And F &O stocks now have this closing auction session. Eventually, it will be translated to everybody. The futures markets continue. That means there's no stopping at 3.15. They go all the way to 3.40 p.m. Speaker 3 (9:16) Essentially, the F &O market is running in parallel without a cash market for a while. Now, I'll tell you what that means. 3.15 to 3.20 is a cleanup time. So, nothing happens at this time. They just take, oh, have you put a bunch of iceberg orders and this orders and that orders? Let's remove it. Everything except limit orders is removed. So, only the limit orders that you had placed in the day. And orders can be placed as limit or market. Limit means you give a price. Market means tell me whatever is there, I'll buy it. And an auction is a bit of a, there is a bunch of bids and a bunch of asks. So bids and offers in that sense. If you take the bids, they're always going to be lower than the offers. The highest bid is the top of the auction table on the buy side. The lowest offer is the top of the auction on the offer side. There's always a difference. 100 rupees, 50 paisa. So the bid-ask spread, as we call it, is 50 paisa. This is just a primer into that. So in Speaker 2 (10:16) this one, the guy is willing to buy at 100, but the highest person willing to buy is 100, and the lowest person willing to sell is 100.5, and hence there's a gap. Because Speaker 3 (10:24) every top has a certain quantity. So how many shares will trade at 100? Somebody is offering... thousand shares at a hundred. That means you can trade one lakh rupees. So if you give a market order for one lakh rupees, it will get executed. If you do a market sell order for one lakh rupees, it will trade at a hundred rupees because a thousand shares will trade. Similarly, if there were 50 shares on the offer side at a hundred rupees, 50 paisa, and you give, I don't know, a 50,000 rupee order, then slightly less than 500 shares would trade because 50,000 doesn't divide exactly by 100 rupees, 50 paise. So that's how the offer and bid are, right? So you would always find in an auction that the highest bid is always lower than the lowest ask or the top of the bid is lower than the top of the asks in that sense. The closing auction session will change all of this. When you have an order in a normal way, which says, oh, well, you know what? I want to sell at 100. If there's a buyer at 100, that will instantly get executed and that order will go away. The next set of guys will come on. Speaker 2 (11:39) That's right. Speaker 3 (11:40) In an auction session, there is no matching. People just place their orders saying, tell me, forget what's on the other side. Just tell me what you want to sell at. So you, at 315 to 320, there's the cleanup. 320 things suddenly open up for new market and limit orders. In limit orders, you can say, listen, I want to sell this stock at 100 and I want to sell this quantity. Somebody else, like the Shrey can come in and say, I want to sell it, but I want to sell it at 101 rupees. Similarly, a buyer can say, I want to buy at 99. I want to buy at 105 also. The problem is, now, if somebody wanted to buy at 105 and you wanted to sell at 101, technically, the trade should be immediately matched, right? Now, it's not matching. You want to see the order book with somebody wanting to buy at 105, somebody wanted to sell at 99. And they currently continue to exist because there is no matching yet. Speaker 2 (12:35) So now what time period are we talking about? You mentioned till 3.15 normal trading occurs. 3.15 to 3.20 the limit orders can exist and can continue to be placed perhaps. They can't continue to be placed but the old ones continue to exist. And the market orders are all cleaned up. And now the world comes back to life at 3.20. And what happens at 3.20? So Speaker 3 (12:55) 3.20 to 3.25, it's five minutes. You can place. Market orders or limit orders. Okay. Market orders, there's no price, so you just wait. They're not getting executed. Limit orders are just being built. The order book is being built up. Now, as the order book builds up, it takes five minutes. And, you know, the price range is 2 % or so above the price at 3.15 and 2 % below. So you can't do like crazy ranges. You just have 2 % up and down. Speaker 2 (13:24) So you can't randomly be like 50 % of the price. You can't do that stuff. Speaker 3 (13:29) So Speaker 2 (13:29) you Speaker 3 (13:29) end up with this thing which says, well, you know what? I've got a bunch of people who want to buy, a bunch of people who want to sell. They're different quantities. Speaker 1 (13:36) Yeah. Speaker 2 (13:36) Right? So from 320 to 325, you're continuing to build up these limit order books. And that stops at 325, I guess. And Speaker 3 (13:45) 325 onwards, no more market orders are allowed. Speaker 2 (13:50) Okay. Which Speaker 3 (13:50) means you can't say, just give me whatever price you discover. And what is this price to discover? The answer is, oh, well, we're going to keep having limit orders into the system, 325 onwards all the way to 330. However, the limit orders that are placed just keep getting added to the order book, right? The thing that is happening at this point is in some kind of dynamic fashion, there is a price that is being discovered. Now, take 321, for instance. There are orders to sell at 105. There are orders to sell at 104, 103, 99, and so on. Buy. There may be orders to buy at 99, 98, 104. Speaker 2 (14:30) Oh, even 104. Okay, sure. All these prices Speaker 3 (14:33) have buyers and sellers. Sure. But there are quantities. So, there's a simple assumption here. If you want to buy at 105, you would be a happy buyer at 104. Speaker 2 (14:44) That's right. Speaker 3 (14:44) And at 103, your price is below that. So, if you wanted to buy 10 shares, And somebody wanted to buy 10 more shares at 104. You want to buy 10 shares at 105. The quantity that can be bought at 105 is only 10 shares. Speaker 1 (15:00) But Speaker 3 (15:01) at 104 is 20 shares. Agreed. So it's a cumulative effect on the buy side. Similarly, a person who wants to sell at 99 is also a person who wants to sell at 100, is also a person who wants to sell at 105. So they build up this cumulative book on both sides. And then say, listen, at what price? price can I execute the maximum quantity of shares? Speaker 2 (15:21) So they're trying to find the equilibrium price. Equilibrium price, clearing price? No, equilibrium price where the maximum quantity of shares will get traded. Will Speaker 3 (15:30) get matched. Speaker 2 (15:31) Matched, yes. Speaker 3 (15:32) This involves no market orders. The market orders are saying, will you discover the price first, whatever that price is? This Speaker 2 (15:37) is all just based on limit orders. Speaker 3 (15:39) That's why the limit order book is important. Now, as the limit order book is being built at 321, there's a limit order book. They can instantly, with a bit of math, calculate, oh, this is the correct equilibrium price right now. And this is the equilibrium quantity. Speaker 3 (15:55) 322, more orders come in, they can say, oh, the equilibrium price has changed. It's gone up or it's gone down. And the quantity has also changed. Similarly, all the way to 325 and then 326 and 327, all the way to 330, you would imagine. Speaker 2 (16:09) But Speaker 3 (16:09) SEBI's also said, listen, we know that these last minute people come and do Heraferi, all this stuff. We know this. So can we preempt that? Between 328 and 330. At a random time, every day, the auction stops. So you can't time it to like the last second. So at that time when the auction stops, they say, well, no more orders. We're done. We're going to take the current state and find the equilibrium price and tell you this is the closing price of the day. So the equilibrium price has changed all this way. And then suddenly you've got this fantastic price done. And then. There is something called, you know, we've discovered a price. Who do I give this price to? Yes. The people who did all the hard work. The limit order people, Speaker 2 (16:59) yeah. Speaker 3 (16:59) They are the, you know, the mine workers. The people in suits who own the mine are the people who put market orders, which means first the market orders get executed. That means you've got a market order for, say, a 10,000 shares buy and 5,000 shares sell because they could be sellers and they could be buyers. So first the sellers and buyers are matched. 10,000 versus 5,000. And then, oh, here, you get a price of, let's say, 99 rupees. Sure. Speaker 2 (17:30) But now 5,000 of sales are left or buys are left in your example? Yes. In the market orders. In the Speaker 3 (17:36) market orders. So we said, well, you know what? The equilibrium quantity was maybe 50,000. Speaker 2 (17:41) Yeah. Speaker 3 (17:42) So it says, well, you know what? Let's first finish the market orders with whoever is on the sell side. Because obviously they matched. So the first 5,000 shares goes to... is sold by the selling limit orders but to the buying market orders okay Speaker 2 (17:57) i would like to interject here to