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STT on Option Exercise trades

stt

With effect from September 1, 2019, where the option is exercised, STT at the prescribed rate shall be levied on the “intrinsic value” instead of the settlement price as at present. Further, in this regard, the intrinsic value has been defined as the difference between the settlement price and the strike price of the option.

 

  1. Is it a part of the Budget proposal and is it going to be effective from September 1, 2019?

Yes, this was announced in the Union Budget release by the FM on July 5, 2019, on which day we had commented that it would be huge relief to the option traders as they wont have to worry about squaring off their in-the-money options  before expiry (See comments on Money Control here)

NSE has clarified in it’s circular released on August 20, 2019 that this provision will be applicable from September 1, 2019 (i.e. after the August expiry)

 

  1. What is your view and how will the options traders be benefitted from this change? Kindly explain with a small example.

The move by FM on streamlining STT levy on option exercise will greatly benefit those traders who are holding on to in-the-money options on expiry day. To understand the impact and how it will benefit option traders, let us first understand the meaning of in-the-money options and intrinsic value of options.

An in-the-money (ITM) option is one where the buyer of the option will benefit if the option is exercised. So in case of call options, all options where the strike price is below the spot price of the underlying will be considered as ITM options. Conversely in case of put options, all options where the strike price is above the spot price of the underlying will be considered as ITM options.

Intrinsic value is the difference between the settlement price and the strike price of the option for all ITM options. Let’s take two examples of ITM options (a call and a put)

Type of Option European Call European Put
Underlying Nifty 50 Nifty 50
Lot Size 75 75
Strike Price ?10,700 ?11,000
Spot Price of Nifty ?10,800 ?10,800
Intrinsic Value ?100 ?200
Contract Value of exercise ?10,700 x 75 = 802,500 ?11,000 x 75 = 825,000

 

Upon expiry of these options, they would be deemed to have automatically exercised at the closing price of the day. Under such scenarios, Option traders are currently paying STT at the rate of delivery transactions (i.e. 0.125%) on the full contract value of exercise. Although NSE had clarified in one of its circular in August 2017 that traders have the facility to opt for “Do Not Exercise” instructions for  such ITM options, however most traders were not aware of this and hence never used this facility.

Under the new provisions (going live from September 1, 2019), traders would have to pay STT only on the intrinsic value of the options instead of the full contract value. Continuing the same example, here are the calculations of the STT under the old and new provisions.

Type of Option European Call European Put
Contract Value of exercise ?10,700 x 75 = 802,500 ?11,000 x 75 = 825,000
STT under current provisions ?802,500 x 0.125% = ?1,003.125 ?825,000 x 0.125% = ?1,031.25
STT under the new provisions ?100 x 75 x 0.125% = ?9.375 ?200 x 75 x 0.125% = ?18.75
Savings in STT 99.07% 98.18%

 

As can be seen, the STT levy has reduced by almost 98% to 99% in above typical scenarios. This is logical since when an ITM option is exercised, the gain to the option holder is only limited to the difference between the settlement price and the strike price of the option (i.e. the intrinsic value) and not the full contract value. And STT being a kind of tax, must only be paid on the gains. I wish these changes were brought in earlier. Many traders could have saved huge STT surprises which they ended up paying unknowingly when they happily exercised their options.

To conclude, one may debate that the real profit to the option buyer is even lower than the intrinsic value since he would have also paid a premium to buy that option (and would have also paid STT also on that premium). So, will there be further downwards adjustments to this STT? That’s a question only the Finance Ministry can answer in time to come. For now, they have surely done their job bringing huge relief and joy to the trader community.

 

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