Monday, July 19, 2010

Introduction of Call Aution for Opening price

As of now Opening prices in Indian Market is calculated as first trade on the exchange. The Exchange is unbiased about the price at which it is traded nor it is unbiased about the trade quantity. The opening price calculated necessarily does not denote the fair price because

a) The opening price can be a fair opening price or it can be an outlier on either side.
b) The quantity traded on opening price is immaterial i.e it can be of 1 share or it can be a stake it the company.
c) Such opening price do not give fair idea about the opening price and there is huge volatility at the open.
d) Many players do not consider opening price as price to reckon as it is just one trade.

Theoretically opening price should reflect the new price which is a consensus price after taking into account all the overnight Informational change and Liquidity needs (Fama). Opening price should be able to clear all accumulated overnight market orders and limit orders which are at or above discovered opening price for buying and limit orders which are at or below discovered opening price for selling.

Such opening price is a good price to read and more reliable. Also it will give better perception about the market. Also equilibrium opening price (As referred by SEBI) may have less volatility and will pass the test of reliability.

The answer to such theoretical opening price is call auction for opening price (commonly called as Pre opening session). SEBI and Exchanges have agreed to start pre - opening session which is a welcome move. This will reduce volatility at the open and also make opening price readable. Such problem will definitely reduce the problem of outliers.

The Salient feature of such Pre-opening session will be as follows
a) All market orders and limit order coming in computation of Opening price will be executed at a single price.
b) It will definitely be a better price to read.
c) It will reduce volatility at the open
d) It will give better signals about the market.
e) It will help in interpretation of Informational change which will reduce noise trading (Fama) at the open.
f) Retail Investors can rely on discovered opening price.

We also need Closing call auction to discover Closing price, which is a long way to go(As Closing price is now calculated as VWAP price). I guess to bring Call closing auction will be difficult in near future as Derivative price discovery is done on closing price and till they are stock settled that wont be tweaked, but at least we have Call auction for opening session.

There was Pre opening session and closing session in India before 12 years on NSE, but it was done away with. (I guess the problem was with price discovery algorithm and lately because of VWAP price at close).I hope we won't face same problems.
Also Recent guidelines on Call auction says that Price discovery process will give priority to Limit Orders and than to market orders. Logically it should be priority to market orders(ATO : At the open) and the to limit orders. I am sure SEBI and Exchange has reason behind this.

I welcome your critical comments and suggestions

1 comment:

  1. "Also Recent guidelines on Call auction says that Price discovery process will give priority to Limit Orders and than to market orders"...I guess Limit orders are always preferred by exchanges since they result in tight bid-ask spreads thereby reducing the impact costs...