Explained: How SEBI fee on notional F&O turnover could impact short duration options contracts

BSE said it will have to pay an additional Rs 96 crore, including interest charges, for the period from FY07 till FY24.

Last week, market regulator SEBI told BSE that it will have to pay turnover tax on its derivatives volumes based on the notional value of the contracts traded. Till now, the bourse had been paying turnover tax based on the value of the premium turnover. Through this explainer, we decode the implications of the SEBI move not just for BSE’s profitability, but also for the futures and options (F&O) segment in general.

What is the turnover tax charged by SEBI?

Exchanges have to pay Rs 1 as tax on every Rs 10 lakh worth of turnover.

What does the SEBI directive to BSE mean?

Every options contract has a lot size. For instance, take the case of a Sensex call option with strike price of 75,000. Since the Sensex lot size is 10, the notional value of the contract (strike price multiplied by lot size) will be Rs 7.5 lakh. Say the premium on this option contract is Rs 200. In that case, the value of the premium turnover will be Rs 2,000 (Rs 200 multiplied by 10). So far, BSE had been paying tax on Rs 2,000. SEBI is saying it should pay tax on Rs 7.5 lakh. And this rule is applicable retrospectively, from 2006-07.

Why has SEBI now come up with this rule?

Because NSE is paying turnover tax based on the notional value of its derivatives volumes. If BSE continued to pay tax based on premium value, it would mean different rules for different exchanges.

What is the financial impact for BSE because of the new rule?

The BSE has said that it will have to pay an additional Rs 96 crore, including interest charges, for the period from FY07 till FY24.

How do exchanges make money on the derivatives trades happening on their platform?

They charge a transaction fee on every trade.

Is this fee charged on the notional turnover?

For futures trades, this is charged on the notional value. For options trades, it is charged on the value of the premium.

How much do exchanges charge as transaction fee on derivative trades?

The charges are based on value of the premium turnover. Higher the turnover, lower the fee. For instance, the NSE charges a flat fee of Rs 2,500 up to Rs 3 crore of premium turnover. It charges Rs 4,950 per crore of turnover between Rs 3 crore to Rs 100 crore, and the fee drops to Rs 2,950 for turnover upwards of Rs 2,000 crore.

The BSE charges Rs 1,500 for the first Rs 3 crore and beyond that, the rates are the same as the NSE.

What are the corresponding charges for cash market turnover?

The BSE charges Rs 3,750 per crore of equity turnover and the NSE Rs 3,220 per crore.

So, is derivatives a more lucrative revenue stream for stock exchanges than the cash market?

That depends on the premium turnover. For cash market, the calculation is straightforward. For Rs 1 crore of turnover, BSE will collect Rs 3,750 each from the buyer and seller, and it has to pay Rs 10 as turnover tax to SEBI. The NSE collects Rs 3,220 each from the buyer and seller and pays Rs 10 as tax to SEBI.

With options trading turnover, the profitability can vary significantly.

Why is that so?

Because the exchanges pay turnover tax on the notional value, and charge transaction fee on the premium, which is a fraction of the notional value. If the premium is high, then the transaction fee on that will more than cover for the SEBI turnover tax. But if the premium is very low, it could end up becoming a loss making proposition.

What is the current scenario in options trading?

While options trading volumes have exploded over the last few years, a lot of action is now happening in weekly options. Even there, much of the volumes happen on expiry day. This has led to notional turnover rising at a faster rate than premium turnover.

Explain that

A vast majority of expiry day options traders play in out-of-money (OTM) options contracts. These are options with strike prices of the underlying (index) far away from the spot prices. The premium for such contracts is low since the possibility of the spot price of the underlying rising or falling to the level of these contracts is low.

Can you give an example?

Say the Nifty is trading at 22,300 on expiry day. The options within a 50-point range on either side will command a high premium because the possibility of the Nifty moving by 50 points suddenly is quite high. But the options beyond 200 points on both sides will be available cheap because a sudden 200-point rise or fall in the Nifty in a day is a rare event. For the option buyers, this is like buying a lottery ticket with a huge upside if there is a sharp move.

How does that matter for the stock exchanges?

Because too many traders buying low priced options means less transaction fee, while at the same time, the exchanges will have to pay taxes based on a high notional turnover.

Whom does the SEBI rule hurt more?

Right now, BSE stands to lose more because a big chunk of its derivatives turnover is coming from its weekly options. For the NSE, the proportion of derivatives turnover from weekly options is much lower compared to the BSE. And while NSE’s notional turnover of derivatives is four times that of BSE, its premium turnover is more than 12 times that of BSE, according to a note by I-Sec.

How has BSE responded to the new calculation of turnover on its derivatives turnover?

BSE has raised its transaction fee to offset the higher expense towards the turnover tax. BSE’s rates are now the same as those of rival NSE.

Does this mean NSE benefits from the revised rule for BSE?

In the short term, maybe yes. But NSE too is grappling with the problem of notional turnover rising faster than premium turnover. In FY13, NSE earned Rs 88 on Rs 10,000 of notional turnover. That has now reduced to Rs 19 on every Rs 10,000 of turnover.

How does this affect the competitive landscape?

Both NSE and BSE have been aggressively pushing weekly options contracts. But if action remains concentrated on expiry day and that too in low priced options, the exchanges may have to rethink their strategy. Because they will end up losing more money, though on the face of it, they may be clocking higher volumes.