Higher STT on F&O trims arbitrage fund edge, limited impact on multi-asset funds

Impact on Budget 2026 on arbitrage funds

• Budget 2026 raises STT on futures to 0.05 percent, options to 0.15 percent
• Arbitrage fund returns may fall 0.32% annually due to higher STT.
• Multi-asset funds see minimal impact from the STT hike

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Budget 2026 has raised Securities Transaction Tax (STT) on futures and options trades, a move that increases transaction costs in the derivatives market. While the hike may appear marginal, it has meaningful implications for arbitrage funds, which rely heavily on cash-futures spreads. The impact on multi-asset strategies is expected to remain limited.

In her Budget for 2026-27,  finance minister Nirmala Sitharaman has proposed to raise STT on futures from 0.02 percent to 0.05 percent, while on options premium and option exercise it will be increased to 0.15 percent from 0.10 percent. The change increases the cost of rolling and churning positions, which forms the backbone of arbitrage strategies.

Arbitrage funds: returns take a small but visible hit

Arbitrage funds typically generate returns by simultaneously buying equities in the cash market and selling futures to capture price differentials. Since these trades are executed at scale and rolled over frequently, even small increases in STT can shave off returns.

According to estimates shared by Edelweiss Mutual Fund in a Budget note, the incremental increase in STT could lead to an annualised impact of around 0.32 percentage points on arbitrage fund returns. This assumes an average arbitrage exposure of about 70 percent and churn in roughly 20 percent of the portfolio.

"The increase in STT on futures and options trades is expected to trim arbitrage fund returns by roughly 30 bps annually. Despite this, arbitrage funds continue to offer better relative appeal versus liquid and short-duration debt funds. The effect on SIFs is likely to be even smaller. In the case of the Altiva Hybrid Long Short Fund, the estimated impact is about 5 bps," said Radhika Gupta, MD and CEO, Edelweiss MF.

While the absolute impact may seem modest, it matters for a category where returns are already closely aligned to liquid fund yields.

Post-tax, the return differential between arbitrage funds and liquid funds is expected to narrow further. The note suggests that if liquid funds deliver around 7 percent, the post-tax return gap between arbitrage and liquid funds could compress to about 0.90 percentage points, compared with over 1.2 percentage points earlier.

While liquid funds are taxed at 30 percent, arbitrage funds are taxed at 12.5 percent for long-term gain.

“The sharp STT hike on futures will trim arbitrage fund returns by around 30 bps annually, narrowing their yield edge over liquid and ultra-short funds. While arbitrage funds remain low-volatility and tax-efficient, long-term investors are likely to stay focused on core equity strategies rather than short-term parking tools," said "Anup Bhaiya, Founder Money Honey Financial Services.

Multi-asset funds: impact remains muted

The impact on multi-asset allocation funds is less pronounced. These strategies typically have much lower exposure to pure arbitrage trades and rely more on directional equity, debt, or alternative strategies.

The Edelweiss MF, for instance, highlights that a multi-asset allocation fund with an average equity arbitrage exposure of around 25 percent would see an impact of about 0.08 percent on annual returns due to the STT hike.

Arbitrage funds may deliver slightly lower post-tax returns, but they continue to offer lower volatility and equity taxation benefits when held for the long term. Multi-asset funds remain largely insulated from the change.