Hike in STT on FnO Trades: Traders Expect Delayed Market Impact

In recent years, India has witnessed a remarkable surge in Futures and Options (F&O) trading. This growth can be largely attributed to the increasing participation of retail investors, many of whom are attracted by the potential for high returns and the ability to trade with leverage. 

The astronomical spike in F&O trading volumes has caught the attention of major regulatory bodies, including the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), who have expressed concern about the potential risks associated with this trend.

In response to the concerns raised by the regulatory bodies and to address the unchecked rise in derivative trades, the Government of India increased the STT on F&O trades.

Hike in Securities Transaction Tax (STT) on Futures and Options (F&O) Trades 

During the recently concluded Union Budget 2024 presentation, the Finance Minister announced that there was a hike in the Securities Transaction Tax (STT) on Futures and Options trades.

In India, STT is levied only if you sell equity and equity-related futures and options contracts. If you buy futures or options, STT is not levied. Here is a table comparing the tax rates on the sale of options and futures contracts before and after the Budget 2024 hike. 

This increase represents a significant 57% to 60% hike in the STT rates for futures and options contracts. The government expects this move to not only generate additional revenue but also to potentially moderate the excessive speculation in the derivatives segment.

However, an important point to note here is that the hike in the Securities Transaction Tax on the sale of futures and options would only come into effect on October 1, 2024. 

Assessing the Impact of the Hike in STT on F&O Trades

To better understand the impact of this STT hike on derivative traders, let us consider two hypothetical scenarios: one with the rates before the Budget 2024 hike and another with the newly hiked rates.

Assume you wish to trade in the Nifty 50 index futures and options contracts. The lot size of the contracts across both the derivative segments is 25. Here are the two scenarios with their respective STT calculations. 

• Scenario 1: STT Rates Before the Hike

Imagine you sell one lot of Nifty 50 futures. If the current price is Rs. 24,000, the total futures contract value would be Rs. 6,00,000 (Rs. 24,000 x 25). In this case, the STT you need to pay would be Rs. 75 (Rs. 6,00,000 x 0.0125%). 

Assume you sell one lot of Nifty 50 call options with a strike price of 25,000 and a near-month expiration date. If the option premium for this contract is Rs. 4, you would have to pay an STT of Rs. 0.25 (Rs. 4 x 25 x 0.0625%).

The total STT paid over the sale of both of these futures and options contracts comes up to Rs. 75.25 (Rs. 75 + Rs. 0.25).

• Scenario 2: STT Rates After the Hike

Let us take the same trades mentioned above. With the new STT on F&O trades rate, the total tax you would have to pay comes to around Rs. 120 (Rs. 6,00,000 x 0.02%) on the futures contract. 

Similarly, the total tax you must pay on the options contract trade would be Rs. 0.40 (Rs. 4 x 25 x 0.1%). The total STT paid over the sale of both of these futures and options contracts comes up to Rs. 120.40 (Rs. 120 + Rs. 0.40).  

• Difference in STT on F&O Trades

The increase in STT on F&O results in an additional cost of Rs. 40 for futures trades and an additional cost of Rs. 0.15 for options trades. That being said, it is important to note that the cost will rise exponentially if you trade in contracts with larger lot sizes or if you increase the number of lots that you sell. 

Impact on the Market Due to the Hike in STT on F&O Trades 

The hike in STT on F&O trades is likely to have several far-reaching effects on the broader market. However, the impact is likely to be delayed. This is due to the fact that the increased STT rates only come into effect on October 1, 2024. Until the time the hiked rates come into effect, traders who sell futures and options will continue to pay STT at 0.0125% and 0.0625% for options and futures, respectively. 

Many market experts and experienced derivatives traders expect the increase in STT to have an impact on algorithmic trading. Also known as algo trading, algorithmic trading involves using pre-programmed computer algorithms to execute trades. Since it involves the use of computer programs, algo trading can execute a large number of trades within a short span of time, something that is humanly impossible. 

The profit potential of each algo trade is often very low, necessitating the need for multiple quick trades. The increase in STT is likely to impact traders who use algorithms since each trade they make will now incur an additional cost. Traders will now have to adjust their strategies to account for the increased costs. Otherwise, their erstwhile profitable trades may end up in losses. 

Another major effect of the hike in STT on F&O trades is likely to be in the form of a shift in trading behaviour. A large number of institutional and retail traders in the derivatives segment place more intraday orders compared to positional orders. Quite a few market experts expect intraday volumes to go down and positional trades to increase as a result of this hike in STT. 

Since the profit potential on intraday trades is usually lower, experts think that traders will attempt to hold onto their derivatives positions for longer in the hopes of generating higher returns and reducing the impact of the increased STT burden on their returns.     

Conclusion

The hike in STT on F&O trades represents a significant regulatory intervention in India's rapidly growing derivatives market. Although the move is aimed at curbing excessive speculation and increasing tax revenue, it is likely to have wide-ranging impacts on the derivatives market. The true impact of the increased STT, however, can only be seen when the rule comes into effect on October 1, 2024.  

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