Retail investors should avoid derivatives

Unless you know the rules completely, you could end up paying higher STT than your profit

Imagine investing about Rs 11,250 in the stock market and getting a return of Rs 6.08 lakh in a span of five minutes. But when the broker sends you the contract note, the securities transaction tax (STT) for the trade is over Rs 24 lakh — almost four times the profit — and it’s not a printing mistake.

It happened with 27-year-old management student Chirag Gupta. When about five minutes were left for the markets to close, Gupta saw that he could buy Nifty call options at 5 paise per unit and make a profit of around Rs 2.75 a unit. He bought options that Nifty will close above 8,600 and it closed at 8,602.75. Gupta bought all the Nifty lots (3,000) he could in the short span of time. One Nifty lot has 75 units. Later, he realised that his broker had deducted over Rs 24 lakh from his trading account for STT. Gupta’s mistake: he let the option expire.

The calculation of STT is different if a trader squares off the position before expiry and if he lets the contract expire. “If a person squares off his long position before the market closes, STT of 0.05 per cent is levied on the premium paid when contract is sold. However, if the contract expires, the STT rate is 0.125 per cent, and is charged on the entire settlement value of the contract, including the value (or price) of the asset,” says Venu Madhav, chief operating officer at Zerodha. 

Brokers suggest that irrespective of whether a trader has a put option or a call option or whether he is in profit or loss, he should ensure that all the trades are settled before the expiry of contract. Brokers do have a mechanism to prevent such issues. “Most brokers track such trades. On the last day of expiry of contracts, we send messages and emails to customers to square off their positions. If clients still fail to do so, brokers square off the trades to prevent losses to the client,” says Vikas Singhania, executive director at Trade Smart Online. But if the trades happen in the last few minutes, as in Gupta’s case, the broker cannot do much.

Brokers are not clear on why the taxation differs. Some say it’s a penalty by the exchanges. They point that that the way STT is calculated on expiry of contract can impact the entire financial system — not just the trader. Umesh Mehta, head of research at Samco Securities, explains: STT is deducted by the broker after the trade and passed on to the stock exchanges. If their customer does not have enough money to pay the STT, it’s the brokers’ responsibility to pay. If a broker does not have the required net worth, he can go bankrupt. “I could get only 3,000 lots. 

I would have easily bought 20 times the contracts, if available, as I thought it was an arbitrage,” says Gupta. In such a case his tax liability would be around Rs 4.8 crore. Gupta is running a petition requesting policymakers and regulator to change the calculation of STT on contracts that expire (http://bit.do/thepetition).