Analysts divided over impact of hike in STT on F&O volumes

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Analysts are divided over the impact of the increase in securities transaction tax (STT) on futures and options (F&O) volumes. While some predict the higher transaction cost will significantly decrease profit margins and lead to a decline in F&O participants, others argue that previous tax increases had little to no lasting effect on F&O volumes.

According to some analysts, the tax hike is likely to make it tougher for short-term traders, arbitrage houses, high-frequency and retail traders to earn profits through F&O trading, given the potential for increased costs. They anticipate the changes will affect the number of F&O participants.

“This could certainly reduce the profit margins of F&O traders,” said Ruchit Jain, lead research at 5paisa.com.

Short-term traders, arbitrage houses, and high-frequency traders account for 90 percent of F&O trading volumes.

A deterrent

However, other analysts suggested that previous tax increases had only a temporary and minimal impact on F&O volumes. In the past, there have been several efforts to discourage retail participation and small traders from trading derivatives, including increasing the margin requirements for F&O trading and implementing the exercising of F&O on expiry. However, these measures mostly served as sentiment dampeners and did not effectively address the individual risk tolerance of traders, analysts added.

The primary objective of the proposed STT hike may be to deter excessive trading in the F&O segment. A recent study by the Securities and Exchange Board of India suggested that about 90 percent of individual traders in the equity F&O segment suffered losses during FY22. Although the tax may generate additional revenue for the government, this may not have been the main reason for the increase, analysts said.

The Lok Sabha passed the Finance Bill on March 24, which included the hike in the STT on the sale of futures and options. The STT on the sale of securities futures was raised to 0.0125 percent from 0.01 percent, which is effectively a 25 percent increase. Additionally, the STT on the sale of options was increased to 0.0625 percent from 0.05 percent, which is also 25 percent higher.

To achieve a more effective reduction in trading volumes, SEBI and the exchanges may need to link trading volumes and open interest with the disclosed income and wealth of participants, analysts suggested.

According to Rahul Ghose, founder of Hedged, an algorithm-powered advisory platform, the government could encourage the use of safer styles of trading derivatives to address the significant losses occurring in the F&O market. One way to achieve this is by promoting the use of hedged positions, which can limit losses to the level retail participants are comfortable with and manage their margin requirements effectively.

Ghose also suggested regulating the educational information provided to traders and investors, much of which is misleading and contributes to further losses among retail traders. Currently, this regulation is implemented in a haphazard manner, adding more confusion to an already complex field.

Volumes in the derivative segment remained close to all-time highs every month since last year. The average daily turnover in the derivative segment was Rs 150.67 lakh crore so far in FY23, up 120 percent from Rs 68.35 lakh crore in FY22.