STT anomaly on exercised options pose serious risks for stock traders, brokers and Exchanges
Retail investors trading in stock options beware. The Securities Transaction Tax (STT), which is a massive multiple of their entire trade, has been hitting unaware investors on options expiry day. And, neither the market regulator not the National Stock Exchange (NSE) has put up any warning signs.
A few cases being discussed on social media, where retail traders have been charged STT, which is a huge multiple of their entire trading in exercised options. One Chirag Gupta had even started an online petition
that has received over 7,500 signatures. While this anomaly can completely wipe out the trader or broker, many of them are not even aware till they are hit.
The STT in case of exercised options is charged at a rate of 0.125% of the entire contract value while it is 0.05% of the premium value if sold on the exchange.
Aftab Khan, a small trader from Karnataka is running from pillar to post after he was hit by the STT anomaly. In one transactions on the National Stock Exchange (NSE)'s futures & options (F&O) segment, he could not square off his options, which expired with some value. For the transaction, he earned a profit of Rs2.08 lakh, however the STT levied on him was Rs6.26 lakh making him to pay Rs4.12 lakh to the broker.
Similarly, Mr Gupta, who had started an online petition, also faced with a huge STT. Here is what he says...
"This is an incident that happened with me on the last options expiry. On 25 January 2017, the expiry for January contracts, I had bought 8600 Nifty calls at 3.25pm for Rs.0.05 as I was 100% sure that Nifty will close above 8600 based on my 25 minutes weighted average price calculations. True to my expectations, Nifty closed at 8602.75. I had bought 3000 lots (one Nifty lot was 75 units at that time) of Nifty 8600 call options at 5 paise, paying a premium of Rs11,250. By the numbers, you can see that I should have made a profit of about Rs6,07,500 (2.7x2.25 lakh) right? But what followed was beyond comprehension.
I did make a profit on this trade because I let the option expire with some value. But much to my surprise, at the end of the day when I received the contract note, I found out that the STT in case of exercised options was charged at 0.125% on the entire contract value as opposed to 0.05% on the premium value if I had sold them on the exchange. So even though I did make a gross profit on this trade, to my shock, I ended up with a huge loss of Rs18 lakh because I had to pay STT of over Rs24 lakh. If I had sold the options before the market closed, the STT I would have had to pay would have been a few thousand rupees, but holding it just for a few minutes extra cost me over Rs16 lakh in losses. Are Securities And Exchange Board of India (SEBI) and the Government of India aware of how traders like me can lose their hard-earned savings in this manner?"
The question that arise after such examples, is why there is anomaly in the way STT is levied differently and why there is a huge difference in the rates, one at 0.125% on entire value and other at 0.05% on premium? Since majority retail traders believe that the downside to an option buyer is the premium only, they need to get a warning about the STT applicable, if they are about to allow the option to expire with some value.
The National Stock Exchange (NSE) on its website says
STT is applicable on all sell transactions for both futures and option contracts. “Value of taxable securities transaction relating to an ‘option in securities’ shall be the option premium, in case of sale of an option in securities. Value of taxable securities transaction relating to an ‘option in securities’ shall be the settlement price, in case of sale of an option in securities, where option is exercised,” NSE says.
According to BSE, during 1 October 2004 to 31 May 2008, the Budget had provided that in the case of taxable securities transaction relating to option in securities, the tax should be the aggregate of the strike price and the option premium of such options in securities. The STT was charged at 0.01% from 1 October 2004, 0.0133% from 1 June 2005 and then at 0.017% from 1 June 2006.
As per NSE, the current STT is being levied as per the Finance Act 2008. The Exchange has reportedly taken up the issue of this anomaly in STT where options is exercised with SEBI and the government and hope to get a solution soon.
What is more serious in these cases is if the client did not have any funds in his account, then the Exchange would debit the money from the broker's account. In Mr Gupta's case, the broker would have to pay Rs24 lakh in case there was no money in his account. "If a bunch of clients, like me, say had bought three lakh lots with around Rs10 lakh, the potential losses just because of STT would have been over Rs24 crore. What if the broker was not liquid enough to make up for this loss? This could easily be Rs24 crore or Rs240 crore or even Rs2400 crore. Would not such losses be a widespread systemic risk to everyone in the capital markets," Mr Gupta asks.
According to NSE, STT payable by the clearing member is the sum total of STT payable by all trading members clearing under him and the trading member's liability is the aggregate STT liability of clients trading through him.
The STT for exercised options should be either brought down to same levels that are applicable when trading on the markets, or else it can open a trading window aftermarket hours on expiry day to close out all in the money options similar to the post-market trading session for equity.
At present, brokers are given a 20-minutes window in equity market post closure of the market for the day so that they can scan their logs and square off positions. Similar window is required for options as well to remove the anomaly in levy of STT.
We sent emails to market regulator SEBI, which said that it has been forwarded to the concerned department.