The mutual fund industry has proposed changes to the way equity futures are valued at market close, aiming to reduce sharp and sometimes unpredictable swings in the net asset values (NAVs) of arbitrage funds, according to a report by Moneycontrol citing people familiar with the matter.
The proposal seeks to align the closing mechanisms of the cash and derivatives markets by calculating a theoretical or fair-value price for futures.
This would be based on the final cash-market closing price determined through the Closing Auction Session (CAS), along with the prevailing cash-futures spread.
Closing Auction Creates Valuation Mismatch
Arbitrage funds, which manage around ₹3.5 lakh crore, generally buy shares in the cash market while simultaneously selling their futures contracts. Since the positions offset each other, movements in one should broadly be balanced by the other.
However, the introduction of the CAS has created a timing and pricing mismatch. Cash-market prices are now established through the closing auction, while equity futures continue trading beyond that period and use a separate methodology to determine their closing value.
This can result in the cash and futures legs of an arbitrage position being marked at prices that do not accurately reflect their economic relationship. Consequently, funds may report sizeable daily NAV gains or losses despite little change in the underlying arbitrage position.
Proposed Fair-Value Futures Price
The industry has suggested calculating the futures closing price using the formula: CAS cash closing price + predetermined cash-futures spread.
The spread could be calculated from the relationship between the cash-market VWAP and the corresponding futures price over a specified period before the close. The regulator and exchanges would need to decide the exact calculation method and time window.
Such a system could provide more stable NAVs and make entry and exit pricing fairer for arbitrage-fund investors.
The proposal could also have wider implications for the derivatives market. A mathematically linked closing price could potentially reduce the need for futures markets to remain open after the cash-market close.
However, any changes would affect clearing, settlement, margining and mark-to-market calculations, meaning exchanges and clearing corporations may need to revise existing frameworks.