
In her Budget for 2026-27, Finance Minister Nirmala Sitharaman has proposed significant increases to Securities Transaction Tax (STT) on derivatives trading. According to reports from Moneycontrol, Mint, and CNBC TV18, STT on futures has been raised from 0.02 percent to 0.05 percent, while options premium and option exercise will increase to 0.15 percent from 0.10 percent. These changes increase transaction costs in the derivatives market and particularly impact arbitrage funds that rely heavily on cash-futures spreads. As per Mint, the increase is small in absolute terms but has material implications for arbitrage funds that depend on cash-futures spreads to generate returns. Finance Minister Nirmala Sitharaman clarified in an interview with PTI that the recent hike in Securities Transaction Tax (STT) on futures and options (F&O) trading is aimed at protecting small investors, not boosting government revenue. She explained that the finance ministry has received numerous requests for measures to prevent retail investors from suffering heavy losses in the F&O segment, citing a study that over 90% of new entrants in the F&O market have faced significant losses.
According to latest estimates from Edelweiss Mutual Fund as reported by CNBC TV18, the incremental increase in STT could lead to an annualised impact of around 30-32 basis points on arbitrage fund returns. Bhavesh Jain from Edelweiss MF noted that arbitrage funds currently deploy around 70-75% of their assets in arbitrage trades that are rolled over monthly, with the cost increase being three basis points. After including rollover and portfolio churn costs, the overall impact on returns could be higher. As reported by Moneycontrol and Mint, this assumes an average arbitrage exposure of about 70 percent and churn in roughly 20 percent of the portfolio. However, Upstox reports suggest a more conservative but still significant impact, with Ronak Morjaria from ValueCurve Financial Services estimating a reduction of approximately 0.25% to 0.30% annualised returns from the next fiscal. The revised STT rates will be effective from April 1, 2026, and the impact will start reflecting in returns after that date. The SBI Arbitrage Opportunities Fund serves as an example, where the total load on profit increases from 0.61% to 0.93% post-Budget 2026, with STT drag rising from approximately 0.20% to 0.52%. The Economic Times reports that arbitrage spreads are usually narrow, often 0.6%–0.8% per month, and higher transaction cost per trade eats into a meaningful portion of that spread, with the sector facing a drag of 25 to 35 basis points on annualised net returns.
While the absolute impact may seem modest, it matters significantly for arbitrage funds where returns are already closely aligned to liquid fund yields. According to Moneycontrol and Mint reports, post-tax, the return differential between arbitrage funds and liquid funds is expected to narrow further. The note suggests that if liquid funds deliver around 7 percent, the post-tax return gap between arbitrage and liquid funds could compress to about 0.90 percentage points, compared with over 1.2 percentage points earlier. While liquid funds are taxed at 30 percent, arbitrage funds are taxed at 12.5 percent for long-term gain. As per Mint, the increase in F&O STT rates will narrow the yield advantage of arbitrage funds over liquid and ultra-short funds, but Jain from Edelweiss MF noted that arbitrage funds may still remain more tax-efficient compared to liquid funds and the post-tax return gap will remain in favour of arbitrage funds. However, CNBC-Awaaz reports suggest the 150 percent hike in STT on futures segment narrows arbitrage opportunities, with net returns potentially dropping by annualized 0.20% to 0.40%, diminishing their appeal as a low-risk, short-term money parking alternative. Upstox reports that while arbitrage funds remain low-volatility and tax-efficient, investors should reassess post-tax ROIs after accounting for this drop in Arbitrage Fund returns and then compare it versus Liquid/Ultra Short Term Funds for temporary parking of funds.
The impact on multi-asset allocation funds remains significantly less pronounced due to their different investment approach. As reported by Moneycontrol and Mint, these strategies typically have much lower exposure to pure arbitrage trades and rely more on directional equity, debt, or alternative strategies. A multi-asset allocation fund with an average equity arbitrage exposure of around 25 percent would see an impact of about 0.08 percent on annual returns due to the STT hike. According to CNBC TV18, Jain noted that the STT increase may also impact other hybrid products such as balanced advantage funds, equity savings funds and hybrid long-short funds, though the impact may be smaller. For BAFs and Equity Savings Funds, the impact is only on the derivative portion used for hedging, so overall returns may dip marginally. Upstox reports that the following categories will also see a marginal dip in performance because they use arbitrage to hedge: Balanced Advantage Funds (BAF) and Equity Savings Funds, with the impact being only on the derivative portion used for hedging. Anup Bhaiya from Money Honey Financial Services noted that while arbitrage funds remain low-volatility and tax-efficient, long-term investors are likely to stay focused on core equity strategies.
Market experts have provided mixed perspectives on the STT hike's broader implications. Raamdeo Agrawal, Chairman & Co-founder of Motilal Oswal Financial Services, warned that the STT hike makes many high-frequency and arbitrage trades unviable, which will squeeze market liquidity and leverage in the short term. Atul Shinghal, Founder & CEO of Scripbox, noted that the 150 percent hike in STT on futures segment narrows arbitrage opportunities, with net returns potentially dropping by annualized 0.20% to 0.40%. However, Harish Krishnan, Chief Investment Officer of equities at Aditya Birla Sun Life Asset Management, which oversees nearly $22 billion in stock assets, believes there's still room for manoeuvring. As reported by The Economic Times, "Arbitrage is dynamic," said Krishnan. "If returns fall, some capital exits, which can widen spreads and partially offset the impact." Anurag Mittal from UTI AMC remained optimistic, stating that near-term yields may see pressure, though demand remains supportive, and expecting the yield curve to remain steep. He suggested that moderate duration products like corporate bond funds or income plus arbitrage funds remain most attractive from risk reward perspective. Pankaj Mathpal, MD & CEO at Optima Money Managers, noted that arbitrage funds generate returns by exploiting price differentials between the cash and futures markets, and a higher STT increases transaction costs and therefore compresses the net arbitrage spread, leading to a marginal reduction in returns. However, since arbitrage strategies operate with low volatility and market spreads tend to adjust over time, the overall impact on absolute returns is expected to be limited as fund managers factor these statutory costs into their trade execution.