Key Takeaways
- STT on futures jumped sharply, while the tax on options barely moved.
- Options now account for ~95% of F&O volume, making the tax hike potentially counter‑productive.
- Higher transaction costs risk eroding futures liquidity and could hurt overall price discovery.
- Industry veteran Nithin Kamath urges a shift to product‑suitability norms instead of repetitive tax hikes.
- Investors should watch futures turnover, broker sentiment, and any regulatory moves toward suitability testing.
The Hook
You ignored the fine print on the new STT hike and now your futures strategy might be on thin ice.
Why the STT Hike Misses the Mark for Futures Traders
India’s Finance Ministry announced a higher securities transaction tax (STT) on equity derivatives, targeting primarily futures contracts. The intention, as framed by officials, is to curb speculative excess in the futures‑and‑options (F&O) segment. In practice, the tax increase is uneven: futures face a steeper levy while options receive only a modest bump. This asymmetry is crucial because the market has already migrated most speculative activity into options—approximately 95% of daily F&O turnover now sits in option contracts. By making futures costlier, the policy inadvertently nudges the remaining futures traders toward the very instrument—options—that regulators fear most.
From a technical standpoint, futures contracts provide a linear payoff and are often used for hedging or directional bets with lower premium outlays compared to options. When the transaction cost rises faster than the expected return, the net‑present value of a futures position can turn negative, especially for high‑frequency participants who rely on thin margins. The result is a squeeze on futures volume, a trend already observable in the last two quarters as open‑interest and turnover have flattened despite broader market rallies.
Impact on Market Liquidity and Price Discovery
Liquidity is the lifeblood of any derivatives market. Brokers, institutional hedgers, and retail speculators all contribute to the depth that ensures tight bid‑ask spreads and efficient price discovery. A sustained rise in STT erodes the economic incentive for market makers to provide quotes, particularly on futures where margins are already squeezed. Reduced futures activity can have a spill‑over effect on the cash equity market because many equity traders rely on futures for intra‑day hedging. Lower hedging activity means broader market participants may experience higher execution costs, translating into wider spreads and potentially more volatility.
Historical parallels exist. In 2013, the Securities and Exchange Board of India (SEBI) introduced a modest STT increase on equities, which led to a short‑term dip in turnover but was quickly absorbed as participants adjusted strategies. However, that change was uniform across products. The current selective hike is more akin to the 2020 European Union’s “Financial Transaction Tax” experiment, where higher taxes on certain derivatives prompted a migration to untaxed instruments, undermining the policy’s intent.
Competitor Landscape: How Peers Are Positioning
Brokerage houses such as Zerodha, Upstox, and Angel Broking have publicly warned clients about the rising cost base. Their sentiment surveys show a growing appetite for options strategies, especially long‑gamma plays that benefit from volatility spikes. Meanwhile, larger institutional players like HDFC Bank’s brokerage arm and Kotak Securities are reviewing their futures exposure, considering a shift to over‑the‑counter (OTC) hedges or foreign‑exchange derivatives where tax treatment differs. The competitive pressure could accelerate consolidation among brokers that can absorb higher costs, marginalizing smaller players.
In the broader Asian context, markets like Singapore and Hong Kong have maintained relatively low transaction taxes while imposing stricter suitability checks for complex derivatives. Those jurisdictions have seen steady growth in both futures and options volumes, suggesting that a tax‑heavy approach may not be the optimal lever for market health.
What Product‑Suitability Norms Could Change
Nithin Kamath, founder of a leading discount brokerage, argues that a “death by a thousand cuts” via incremental STT hikes is less effective than clear, enforceable suitability criteria. Such norms would require traders to demonstrate adequate experience, risk tolerance, and capital buffers before accessing high‑leverage futures or exotic options. The upside is twofold: it filters out reckless speculation and provides regulatory certainty for brokers, who would no longer fear sudden tax‑policy swings that can cripple business models.
Implementing suitability standards would also align India’s derivatives market with global best practices. The U.S. SEC’s “Regulation Best Interest” and Europe’s MiFID II framework both embed suitability checks, leading to more transparent risk‑taking and, over time, healthier market depth. While some retail participants may view the move as restrictive, the long‑term benefit is a more resilient market capable of withstanding macro shocks.
Investor Playbook: Bull vs. Bear Cases
Bull Case: If regulators pivot to suitability norms and pause further STT hikes, futures volumes could stabilize, preserving liquidity for hedgers and institutional players. Options may continue to dominate speculative flow, but with clearer risk controls, the market could attract higher‑quality capital, driving premium pricing on volatility products. Investors with exposure to brokerage earnings could see margin improvement as cost pressures ease.
Bear Case: Continued incremental STT increases erode futures profitability, prompting traders to exit or shift to offshore platforms. Liquidity dries up, spreads widen, and price discovery suffers across both derivatives and underlying equities. Brokerage firms that cannot absorb the tax burden may face margin compression or consolidation, leading to reduced competition and higher trading costs for end users.
For portfolio construction, consider the following tactical moves: allocate a modest tilt toward brokers with diversified revenue streams (e.g., wealth management, mutual funds) that are less dependent on futures commissions; monitor futures open‑interest as a leading indicator of market stress; and keep an eye on regulatory announcements regarding suitability norms, which could act as a catalyst for a market reset.