Why Finance Minister Hikes STT on F&Os?

In her Union Budget speech, Finance Minister announced a plan to raise the Securities Transaction Tax or STT on trading in futures and options or F&O. This move aims to deter retail investors from engaging in these high risk financial instruments. Specifically, the tax rate on selling options in securities will increase from 0.0625% to 0.1% of the option premium. Similarly, the tax rate on selling futures contracts will increase from 0.0125% to 0.02% of the trading price. This change is intended to make F&O trading less attractive to individual investors encouraging them to consider safer investment options.

Reasons Behind the Finance Minister's Increase in STT on F&Os

Economic Survey raised concerns about the growing interest of retail investors in trading derivatives which are financial contracts whose value depends on the performance of assets like stocks. The survey emphasized that speculative trading which is essentially betting on future price movements is not suitable for a developing country like India. It suggested that many people are getting into derivative trading because it appeals to their natural tendency to gamble. While trading derivatives can lead to big profits, it also comes with high risks, and the survey implied that this trend might not be healthy for the economy.

Economic Survey 2023-24 highlights that derivatives trading particularly in futures and options attracts retail investors due to their natural inclination towards gambling and the potential for profit. However, concerns have been raised by notable figures like the Sebi chief, Finance Minister, and Chief Economic Adviser about the risks involved, especially for retail investors who might not fully understand the complexities or have the risk tolerance for such trading.

After these warnings, F&O trading is becoming popular. The potential for profit and the rising trading volumes are key drivers of this trend. Experts advise that investors without a good understanding or sufficient risk appetite should avoid F&O trading due to its risky nature.

The popularity of the F&O segment is evident from its substantial growth. In March 2024 monthly turnover in the F&O segment reached an astonishing ₹8,740 lakh crore, an increase from Rs 217 lakh crore in March 2019. Comparatively, the equity cash segment had an average daily turnover of ₹1 lakh crore while the F&O segment's average daily turnover was about ₹330 lakh crore highlighting the segment's massive growth and appeal.

Futures and Options trading involves contracts based on the value of an underlying asset like stocks or commodities. A futures contract is a deal where both the buyer and seller agree to trade an asset at a fixed price on a specific future date. No matter how the market price moves before then, they have to go through with the transaction at the agreed-upon price. In contrast, an options contract gives the holder the right but not the obligation to buy or sell the asset at a specific price within a certain time frame. These financial tools are often used to protect against risks, bet on price changes or take advantage of price differences.

Risks and Trends in F&O Trading

Trading in F&O is risky due to the high leverage involved and market volatility which can result in large losses. Despite being seen as a way to make quick profits in the stock market, most retail investors are actually losing money. A study by the Securities and Exchange Board of India found that 89% of individual traders in the equity F&O segment experienced losses with average losses amounting to ₹1.1 lakh in the financial year 2022.

During the pandemic, the number of people trading in the futures and options segment of the stock market skyrocketed. The number of unique individual traders jumped by more than 500%, going from 710,000 in the financial year 2019 to 4.52 million in the financial year 2021. The head of the capital markets regulator, Buch expressed concern over this surge noting that the regulator is now forced to issue warnings about the dangers of speculative trading in the F&O segment.

This issue has become enough to impact the broader economy. Instead of saving money for long-term investments, households are using their savings for risky speculative trades. This trend is particularly worrying for young people who are losing money in these trades. To address these concerns Securities and Exchange Board of India or SEBI recently approved stricter rules for which individual stocks can be traded in the derivatives market. This move aims to remove stocks that consistently have low trading volumes from the F&O segment to curb speculative trading.

Final Words

Finance Minister's decision to increase the Securities Transaction Tax on futures and options aims to reduce the appeal of these high-risk financial instruments to retail investors. This move addresses concerns raised by the Economic Survey and regulatory bodies about the growing trend of speculative trading which poses risks particularly for those who may not fully understand or have the tolerance for such trades. Despite the surge in F&O trading during the pandemic and its high turnover most retail investors are experiencing losses. To mitigate these risks and protect investors SEBI has introduced stricter rules for stocks eligible for derivatives trading.