Basics of SST: Its Calculation, Tax Change, and Impact On Options

Introduction

Month of September 2019 is starting on good news for option buyers. As STT calculation is getting Changed For Options On Expiry From 01 September 2019.

Finance Minister Nirmala Sitharaman made certain observations to stock market investors in her Budget speech for 2019.

However market participants remained disappointed due to more taxes being levied.

Recently in major announcement with removal of surcharge on long-term and short-term capital gains tax for FPI (foreign portfolio investors) provided some relief to the market.

Another key point benefit that she spoke is of change in calculating the Securities Transaction Tax (STT) in case of exercising Options.

With effect from September 1, 2019 where 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. Read More

What is STT(Securities Transaction Tax)?

STT stands for security transaction tax. STT is imposed every time you buy or sell a security.

It differs for various types of securities such as equities, derivatives (futures and options), bonds, debentures and mutual funds etc.

Earlier STT was levied at 0.125 per cent on the entire settlement price.

This is how STT was getting calculated Earlier

As an illustration Suppose you bought Niftty at strike price of 11000.

However on day of expiry Nifty settled at 11100. If you had exercised this contract, this is how the tax would have been calculated:

Since one contract is made up of 75 shares,

STT Calculation , 11100 * 75 * 0.125% = Rs 1040.62

The reason behind this loss was the exceptionally high STT charged by the exchange on in-the-money (ITM) options that were not exercised by the trader before 3:30 pm on the expiry day.

After The Tax changed In Budget 2019

Sitharaman said in the Budget speech “I propose to give relief in levy of Securities Transaction Tax (STT) by restricting it only to the difference between settlement and strike price in case of exercise of options,”

What does it mean for STT Calculation now?

Strike price is at which a Put or Call option is exercised. This happens if you do not square off your position before expiry.

while settlement price is the final price of the underlying asset against which options are traded.

Settlement price dictate whether options are in-the-money (ITM) or out-of-the-money (OTM) at the expiry.

Let us see how this change would make a impact for options up on expiry

suppose you buy an 11,200 Call (strike price) on Nifty (underlying asset) on September 15 for Rs 60 (75 shares make one contract).

On expiry day, Nifty ends at say 11,250 (settlement price). The 11,200 call is Rs 90 ITM (in the money).

The seller gives the buyer Rs 90 and the buyer pockets the premium of Rs 30.

As per the change in STT, it will be levied on the difference between strike price (11200) and settlement price(11250) i.e. 50 in the said contract.

STT Calculation Now , 50 * 75 * 0.125% = Rs 4.68

Conclusion

What this means for option buyers is that you can let the options expire in the money without having to worry about the much higher STT in cash-settled contracts like Nifty, Banknifty, etc.

This would also mean that option premiums won’t trade at a discount to the intrinsic value on the expiry day like earlier.

I personally feel this change should have been bought earlier. As it was impacting the buyers as well as the premiums on day of expiry.

Write in comments what do you think of this change?