F&O expiry should be delinked from SEBI's closing auction session: Crosseas' Rajesh Baheti

Rajesh Baheti, Managing Director of Crosseas Capital Services, wants the Securities and Exchange Board of India (SEBI) to separate the way index funds discover closing prices from the way futures and options (F&O) contracts expire.

He proposes settling F&O contracts at 3:15 pm, allowing the cash market to carry out its own price discovery over the remaining 15 minutes, so the two processes do not influence each other.

Baheti pointed to the currency segment as an example of how this could work. The segment does not wait for the market close at 3:30 pm. It settles at 12:15 pm using the Reserve

Bank of India's (RBI) reference rate for the day. "It doesn't have to be the prices discovered at the end of the day," he said. "You set a time, and that is the discovered price in the F&O segment for settlement."

His remarks follow the first monthly BSE derivatives expiry since SEBI introduced the Closing Auction Session (CAS) — a 15-minute window at the end of trade meant to help index and passive funds settle at a single, less volatile price. On expiry day, the BSE's Sensex and Bankex indices fell by roughly 2,000 and 3,000 points respectively during the CAS window, before Bankex recovered to close about 1,100 points below its earlier level.

Baheti has criticised the CAS mechanism publicly since before its first expiry cycle.

SEBI Chairman Tuhin Kanta Pandey defended the mechanism, telling reporters the regulator does not see a need for changes and that participation will grow as brokers enable it in their trading apps. Baheti was unconvinced. "SEBI kind of said all is well yesterday (August 27). That's what the papers reported. If all is well, then we shouldn't be having this show about CAS," he said.

The CAS was designed to help index funds and passive funds avoid tracking error — the gap between a fund's returns and its benchmark index — when they rebalance their portfolios. Baheti said the problem is that these funds do not trade in the F&O segment at all, yet F&O contracts are still priced off the CAS-determined closing level.

He referenced an earlier interview in which market commentator Ananth Narayan suggested traders should simply cut back on zero-days-to-expiry (0DTE) options if CAS was distorting price discovery. Baheti sees a pattern in that response. "It's probably to kill the 0DTE market, and this might be one of the ways to do it," he said, adding that this could be an unintended outcome rather than a deliberate one.

Baheti argued the BSE is more exposed to this problem than the National Stock Exchange (NSE). The BSE holds an estimated 32 to 35% share of India's F&O market but only about 5% of cash market volumes. With so little institutional trading in BSE cash shares, and since BSE index levels are calculated from BSE's own closing prices rather than NSE's, he expects the exchange's closing levels to stay volatile. He said this volatility will discourage trading in BSE options over time.

Asked about order manipulation as a possible cause, Baheti pointed to a separate issue: traders placing orders during the session and then withdrawing or modifying them close to the cutoff. Exchange rules currently allow withdrawals up to a set point before close, which he said still leaves an eight-minute window for last-moment changes.

He suggested introducing a penalty for withdrawing or modifying orders placed earlier in the session, since these late changes contribute to the price swings seen during CAS. "There are people out there trading real money in the option segment who are being taken to the cleaners regularly," he said.

Baheti said the cash and derivatives segments do not need a single, shared closing price. "I always maintained if that's what's needed to be done for index and passives, go ahead and do it, but at least allow cash to have 10% or 15% of the market's volumes, and then link it to the F&O," he said.

He proposed expiring F&O contracts at 3:15 pm and allowing the cash market to continue trading until 4:00 pm, so passive fund rebalancing and derivatives settlement no longer share the same price.

The next test for the mechanism, he noted, will come with the upcoming index rebalancing by MSCI, one of the largest global index providers — an event expected to bring another spike in trading volumes around the closing auction window.

For the full interview, watch the accompanying video

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