NSE/BSE Change Rules on Option Expiry To Reduce Excess STT Payouts

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You know, of course, that if you buy options and let them expire in the money, that you pay a ludicrous amount of Securities Transaction Tax. It is 0.1% of the exercised contract price. So a Banknifty 24000 call option, if the Bank Nifty expires at 24001, will pay you Rs. 1 if you have bought it and not sold before expiry. But the STT you pay is Rs. 24001 * 0.1% = Rs. 24! That means you pay the government more tax than the premium you get back!

This was also a problem for brokers. Speculators would play on the expiry day, lapping up options at Rs. 0.1 or such, and rubbing their hands in glee when the market closed Rs. 2 above their strike price. After all, they made 20 times their money, right?

Wrong. They would end up paying Rs. 10 or so as STT on Nifty options, a ludicrously high amount.

See our post on this: Beware of STT when trading options.

NSE and BSE have set up a new mechanism (read this) to solve the STT problem.

From August 31 – the next big expiry – the following changes will happen:

  • For certain strike prices of In-The-Money options, you can choose to exercise or not, at 4:30 pm. (Brokers have to tell the exchanges between 4:30 and 5 pm)
  • You need to tell your broker that you don’t want to exercise your bought options, and you will not receive any premium (or pay STT) even if they are in the money. So at an expiry of 24001, a 24000 call option holder can decide he doesn’t want to exercise, and he will get nothing back (not even the Rs. 1). So, he won’t pay the STT either, as the exercise has not happened.
  • This applies to three call strikes BELOW the closing price, and three put strikes ABOVE. (these are the nearest in-the-money options)
  • Of course, if you don’t say anything, the default choice is to exercise. So you actually have to say no. That’s a good habit, especially when it comes to losing money.

It’s likely that some brokers, like Zerodha, will automatically say “No” to any options where the exercise makes no sense. For instance any Bank Nifty option with less than Rs. 24 as the intrinsic value should not be exercised, as the STT is about Rs. 24. Zerodha has been campaigning for this for a long time, and this is a good way to avoid the big STT pain.

But Don’t Rejoice, STT still applies!

Let’s say the BankNifty expired at 24,050. Would you not exercise the 24,000 call option? Yes, you will pay Rs. 24 to the government but you will get your Rs. 26 back for yourself, no?

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It makes sense to exercise if the intrinsic value at exercise is more than the STT payable. So all options will still pay STT if they are above the margin.

This is an interesting mechanism to cut the STT issue so that the cost to brokers is reduced. In recent times we have even seen that trading in some in the money options completely stops in the last 15 minutes – because it simply doesn’t make sense to trade the option if all you will do is pay STT.  In this situation, a buyer should simply refuse to exercise – a choice that wasn’t available till now.

This is good news, and let’s hope all brokers embrace it. Some of the non-tech brokers take time to do something like this, but most of the frontline brokers should do this immediately.

This is no big deal for the government either. They earned just Rs. 46 lakh rupees from such STT from options on July 27 (the previous expiry). But the earning from futures STT, which is much higher, was Rs. 3.49 crores! The STT on such options is minuscule.

Stay safe and don’t go overboard on expiry day. And in our Capitalmind Premium Slack channel, we will discuss something interesting that might actually benefit from this circular!

No exercise Options STT

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