Beware of STT When Trading Options

Many people who trade options towards the last week of expiry have been excited by the volatility this month – coming after nearly a year of relatively sane trading. Options have high implied volatilities and the daily moves in the Nifty are even higher, of the order of 2% (translation: options haven’t really priced in the moves), which makes the option values look great.

As I write this, the Nifty is at 4870 and the Nifty 4900 call, expiring on Thursday, is at Rs. 48. This means the nifty can move just 2% up from here, and you’ll end up profitable. With a month that’s seen us down over 12% this month, you might expect some sort of a recovery in the last few days.

But note that option prices on the Nifty carry at least a 6 point risk of STT. That is, if you hold till expiry, you’re going to pay Rs. 6 as Securities Transaction Tax on the trade. Towards the last day, options quote at about Rs. 6 less than intrinsic value because of this issue. I’ve made a more detailed video at MarketVision:

Also, commissions are quite high. Most brokerages charge you Rs. 30 to Rs. 50 per lot. A lot of Nifty is sized at 50, so a two-way trade (buy/sell) involves a cost of Rs. 100 per lot on brokerage or subsequent service tax, stamp duty, etc. which could add up to Rs. 150 per lot – that is, for a lot of 50, Rs. 3 per Nifty.

If you’re buying something at Rs. 48, and your costs are Rs. 3 for brokerage+, and Rs. 6 for STT, your breakeven point is Rs. 57 – or nearly 20% higher. You have to keep this in mind when trading options; if you don’t see a ridiculous gain (100%!) you shouldn’t trade the last few days – costs are high.

(A friend runs a brokerage called Zerodha – Disclosure: I’m an advisor - where I trade options – it costs me Rs. 20 per trade, and if I buy 200 Nifty options, my round trip cost on brokerage is very cheap – just Rs. 50 overall or Rs. 0.25 per Nifty. STT still applies, but I hardly even hold long options in the last week, unless the costs are accounted for)

Options are a great trading tool if you understand that it’s a very high risk bet as well. In the context of highly priced options, it may be better if, rather than buying, you **WROTE **strangles or straddles today, for the August expiry; this has the added advantage of the STT loss being priced in by Wednesday and gives you that much of a cushion. As always, there is a huge risk in being short options as well.