In Budget 2026, the STT on futures was raised from 0.02% to 0.05%. The tax on option premiums was increased from 0.10% to 0.15%, while the STT on option exercise was also raised from 0.125% to 0.15%, making derivatives trading costlier across the board.
STT is a direct tax levied on the purchase or sale of securities, including stocks, derivatives, and mutual fund units, on exchanges.
In effect, it’s a transaction tax paid on every trade, regardless of whether the trade makes a profit or a loss.
According to Anup Bhaiya, Founder of Money Honey Financial Services, Budget 2026’s steep hike in STT on derivatives raises trading costs, curbs speculative volumes, and pushes investors back toward long-term, fundamentals-driven equity investing.
Two categories of funds that are expected to see impact from this move are arbitrage funds and specialised investment funds (SIFs).
“The Securities Transaction Tax (STT) hike on F&O at nearly 2.5 times significantly raises the cost of frequent trading. These higher STT costs will eventually affect certain mutual fund categories, such as arbitrage and SIF, as these vehicles rely on high-volume, thin-margin trading. This could marginally increase the effective expense burden for investors in these schemes,” said Manish Kothari CEO, ZFunds.
Impact on arbitrage funds
Arbitrage funds capitalise on price inefficiencies between spot and futures markets. The difference between a security’s spot and futures prices is called the spread. The fund manager captures the spread by selling the futures contract and buying an equivalent position in the spot market.
“While the Budget’s STT hikes on equity derivatives increase costs for all derivative users, the impact on derivative-intensive arbitrage funds is expected to be moderate rather than very high. Industry estimates suggest a drag of around 0.25–0.35% on annualised returns due to higher trading costs,” said Rajani Tandale, Senior Vice President, Mutual Fund at 1 Finance.
According to Radhika Gupta, MD and CEO, Edelweiss Mutual Fund, “The hike in STT on F&O trades is likely to reduce arbitrage fund returns by about 30 bps on an annualised basis. Even so, arbitrage funds should still remain more attractive than liquid and other short-term debt funds.”
| Impact of increased STT on Arbitrage Fund Returns | |
| Incremental increase in STT | 0.03% |
| Average arbitrage exposure in Arb funds | 70% |
| Impact on return (Rollover) | 0.02% |
| Impact on return (Churn) 20% of portfolio | 0.01% |
| Total impact on return (annualised) | 0.32% |
| Post tax return difference between Arb and Liquid fund assuming 7% return* | 1.23% |
| Return difference after increased STT | 0.90% |
*Tax assumed at 12.5% in Arbitrage Funds and 30% in Liquid Fund
Source: Edelweiss MF
For instance, funds with an arbitrage position of 70% and 15-20% churn will see an annualised impact of around 0.3-0.35% at an STT increase of 0.03%, with futures rollover once a month. “With these calculations, investors would not see any significant difference in their post-tax returns,” said Kothari.
Mutual fund experts agree that the arbitrage fund category, which has delivered more than 6% average returns over the past year, remains a good bet.
“The impact is real and most visible in arbitrage funds. The extent depends on the churn within the fund, but we estimate the annualised impact to be in the range of 30–50 basis points,” said Nirav Karkera, Head of Research at Fisdom.
While arbitrage funds delivered strong returns last year, this year’s performance will depend on market volatility and spreads. That said, even after factoring in the STT impact, arbitrage funds continue to offer a post-tax advantage.
“For instance, when you adjust for post-tax returns, it still works out to roughly closer to 5–5.25% in some cases. With traditional fixed-income instruments yielding lower in the current interest-rate regime, the tax efficiency of arbitrage funds still makes them attractive, especially for investors in higher tax brackets,” said Karkera.
Limited hit on SIFs
SIFs are permitted to harness a wide range of derivative strategies to pursue opportunities across rising, falling and sideways markets. Unlike traditional mutual funds, these funds can take derivative exposure for purposes other than hedging and portfolio rebalancing. SIFs are allowed to sell shares without holding the underlying assets, termed as naked short positions, up to 25% of the portfolio. STT hikes are also expected to impact this category of funds.
This new category, which primarily uses futures and options as tactical tools, will see impact vary based on its strategy and derivative allocation.
“Hybrid or strategy-driven schemes with derivative exposure closer to 60–65% could experience a return impact similar to arbitrage funds, while funds with lower derivative usage are likely to see a much smaller effect,” said Tandale.
The STT hike is therefore expected to affect high-frequency and high-turnover traders more significantly, while its impact on retail and long-term investors should remain limited.
According to Kothari, SIFs, limited to 20% F&O positions, will see a milder 0.05-0.10% impact, preserving their yield edge over plain-vanilla debt funds.
As per Edelweiss MF’s Gupta, for SIFs, the impact is expected to be lower than for arbitrage funds. “For example, the Altiva Hybrid Long Short Fund may see an impact of around 5 bps,” she said.
These changes in STT take effect from 1 April 2026, so the impact will be in the May rollover.
“It is too early to estimate the impact of the STT hike on SIFs. The category is still evolving, with wide variation in strategies, churn levels, and market usage. There is limited data to draw firm conclusions at this stage, and it would not be prudent to club all SIFs under a single framework for impact assessment,” said Karkera.