When the Securities Transaction Tax (STT) was first introduced in 2004, most traders railed against it saying that it would literally finish F&O volumes in a nascent market. Nothing of that kind happened. In fact, after the introduction of STT, the F&O volumes have gone up manifold in the last 14 years. But remember that STT can be actually a lot more complicated than you can imagine. Different products like intraday equity, delivery equity, futures and options have different levels of STT imposed.
Let us first understand how the calculation of STT on futures differs from options. The basic difference is that while the STT on futures transactions are still imposed on the notional value of the transaction, the STT on options transactions is imposed on the premium value of the transaction.
|The case of STT on Futures||The case of STT on Options|
|Assume Nifty Futures price at 11,000||Assume Nifty 11,000 Call Premium at Rs.50|
|Lot size applicable – 75 Shares||Lot size applicable – 75 Shares|
|Notional Value of 1 lot – Rs.825,500 (11000 X 75)||Premium Value of 1 lot – Rs.3750 (75 X 50)|
|Rate of STT charged - 0.01%||Rate of STT charged – 0.05%|
|Actual STT payable on 1 lot = Rs.82.55||Actual STT payable on 1 lot = Rs.1.88|
|STT payable by the – Seller of Futures||STT payable by the - Seller|
As can be noted, the STT payable on 1 lot of options is substantially lower than the STT payable on 1 lot of futures. This is despite the fact that the STT on options was hiked 3-fold from 0.017 per cent to 0.05 per cent. The reason is that options are charged STT on their premium value while futures are charged STT on their notional value. This has been one of the key reasons for the rapid growth of option volumes in India and these options account for over 90 per cent of the daily volumes.
To understand exercise of option, you must understand exercise.
There are two ways to exit a long option position. Firstly, you can sell the option in the exchange or you can even go to the exchange and exercise your option. We now shift to understanding the ITM (In the Money) option as it is only in case of ITM options where the concept of exercise becomes relevant. An ITM option has a positive intrinsic value. For example, if you bought a Nifty 11,000 call option at a premium at Rs 50 and the Nifty spot is at Rs 11,035, then the option will be an ITM option. In the case of call options, if the spot price is greater than the strike price it will be an ITM option. The reverse is true in case of put options.
What do we understand by American and European options? A European option can be exercised only on the expiration date while an American option can be exercised on any day prior to the expiry date. An exercise of an option is different from reversing your option in the market. Exercise has nothing to do with market liquidity and can be done with the exchange even if there is no liquidity in the market. Till 2011, index options were European in nature while stock options were American in nature. However, post 2011 NSE has shifted all its stock options also to the European format.
How does excising options change my cost of STT?
There is an interesting anomaly here. Technically, European options cannot be exercised but the anomaly arises on the F&O expiry date. All the ITM options (calls and puts) that are not reversed by the option buyer are automatically considered to be exercised at the closing price. The reason this is anomalous is that only in this case, the buyer of the option is required to pay the STT. That is not all! The STT is charged on the notional value of the contract (not at the option value) and is charged at the delivery rate of 0.125 per cent. Therefore, on the expiry date if your option position is in-the-money, it makes a lot more economic sense to reverse and close out the option than to leave it to expiry.
|You leave an ITM option to expiry||You reverse your ITM option before expiry|
|Option Details: Bought 11,000 Nifty Call @ Rs.75||Option Details: Bought 11,000 Nifty Call @ Rs.75|
|Nifty 1 lot = 75 shares||Nifty 1 lot = 75 shares|
|Nifty Spot Value just before expiry – 11,075||Market price of 11,000 Call Option – Rs.80|
|Notional Value of contract – Rs.825,000||Option Value of contract – Rs.5625|
|STT at 0.125% on contract value – Rs.1,031||STT at 0.05% on option value – Rs.3|
As we can see in the above example, when you leave the ITM option to expiry, there is a sharp incidence of STT. Also, as the buyer, you will end up paying the STT in the event of exercise, against the normal practice of the seller of the option STT.
Here is an important point for options traders to remember. When you let ITM options expire, they are deemed to be exercised. This results in a double whammy. Firstly, it results in STT being calculated at the delivery rate and secondly, the STT is calculated on the notional value rather than the premium value. You must keep that in mind in options trading!
Disclaimer: The above opinion is that of Mr. Ruchit Jain (Equity Technical Analyst - Angel Broking) & is for reference only.