What the STT hike means for your arbitrage fund returns
While the increase is small in absolute terms, it has material implications for arbitrage funds, which depend on cash-futures spreads to generate returns.
Budget 2026 increased transaction costs in the derivatives market by hiking the securities transaction tax (STT) on futures and options trades. While the increase is small in absolute terms, it has material implications for arbitrage funds, which depend on cash-futures spreads. The impact on other strategies is likely to be limited.
In her Budget speech on Sunday, finance minister Nirmala Sitharaman proposed a hike in STT: the tax for futures will rise from 0.02% to 0.05%, while the tax on options premiums and exercised options will increase to 0.15% (from 0.10% and 0.125%, respectively).
Arbitrage funds generate returns by buying shares in the cash market and selling futures to capture price differences. These positions are typically rolled over frequently and executed in large volumes.
‘Still an attractive option’
According to estimates shared by Edelweiss Mutual Fund in a Budget note, the higher STT could reduce arbitrage fund returns by around 0.32% a year. The estimate assumes an average arbitrage exposure of about 70% and portfolio churn of roughly 20%.
The post-tax return gap between arbitrage funds and liquid funds is thus expected to narrow further. The note suggested that if liquid funds delivered around 7%, the post-tax return difference could shrink from about 1.23% to about 0.90%. Capital gains from liquid funds are taxed at investor’s income tax slab rate (the highest marginal rate is 30%), while arbitrage funds are attract just 12.5% long-term capital gains if held for more than a year.
Radhika Gupta, managing director and chief executive of Edelweiss Mutual Fund, said, “The increase in STT on F&O trades is expected to impact arbitrage fund returns by roughly 30 bps on an annualized basis. Even after this, arbitrage funds remain attractive when compared to liquid and other short-term debt funds. In the case of SIFs (specialized investment funds), the impact is likely to be lower than that on arbitrage funds overall. For instance, in Altiva Hybrid Long Short Fund the impact is expected to be around 5 bps."
“The increase in F&O STT rates will narrow the yield advantage of arbitrage funds over over liquid and ultra-short funds. However, arbitrage funds remain a low-volatility and tax-efficient alternative for investors," said Anup Bhaiya, founder of Money Honey Financial Services.
How will it affect other funds?
The impact on multi-asset allocation funds is expected to be smaller, as these funds typically have lower exposure to arbitrage trades and rely more on directional equity, debt and other strategies.
Edelweiss Mutual Fund estimates that for its multi-asset allocation fund, with an average equity arbitrage exposure of around 25%, the annual impact of the STT increase could be about 0.08%.
Equity savings funds, which have arbitrage exposure, will also be affected to extent of their allocation to F&O instruments.
SIFs will also be hit depending on their exposure to F&O segment. A new product category, SIFs are allowed to use F&O to hedge the portfolio and also take short positions.
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