Though the spot equity market may not have reacted favourably to Finance Minister Nirmala Sitharaman’s maiden budget, the situation is different in the derivatives segment. The Modi 2.0 Budget proposed to give relief in levy of Securities Transaction Tax (STT) by restricting it only to the difference between settlement and strike price in case of exercise of ‘options’. This is a big development since options trade costs will now come down, and may boost volumes. Also, now traders will not be worried about compulsorily squaring off in-the-money options before expiry.
A stock option provides an investor the right, but not the obligation, to buy or sell a stock at an agreed upon price and date. The strike price tells you whether an option should be exercised. It is the price that a trader expects the stock to be above or below by the expiration date.
At present, STT is charged on the entire contract value for options. As a result, most traders squaring off their positions ‘In The Money’ (ITM) earlier to prevent higher STT outflow. Squaring off means a trader buys or sells a particular quantity of a security/asset and later reverses the transaction, in the hope of earning a profit. ITM indicates that the option has value in a strike price favourable in comparison to the prevailing market price of the underlying asset.
“The STT change is a big relief to options traders as the STT charge will no more be made on the value of the contract but on the difference between the strike price and the market price only. For options that close In The Money, it would not force traders to square up in the last hour of trading as was the case earlier. Most traders would try squaring up to avoid the higher STT that made it expensive to hold onto a position that was in the money ahead of expiry. Now the cost is not restrictive and one can allow it to expire in the money to lock in gains,” says Rohit Srivastava, Fund Manager – PMS, Sharekhan by BNP Paribas said.
At present, if an option contract is exercised, the trader had to pay STT of 0.125% of the settlement price. If the option is not exercised, then the STT was 0.05% of the premium. This situation changes with the Budget proposal. Imagine you are a derivative trader. You exercise your options and your ITM (In The Money) option strike was, say 11800, on expiry with the spot at 11900.
At present, you would have to pay STT of 11900*75*0.00125 = Rs 1,115. But thanks to the Budget proposal, now STT will be (11900 – 11800)*75*0.00125 = Rs 9.375. That is a huge reduction because in the previous method STT was calculated on the entire settlement price. The easing of STT on options will drive preference for options derivatives, experts say.