The Securities Transaction Tax (STT) on futures and options trading was increased in Budget 2026, which raises transaction costs in the derivatives market.
Impact of STT Increase on Derivatives and Arbitrage Funds
The increase has significant ramifications for arbitrage funds, which mostly depend on cash-futures spreads, even if it may seem little. It is anticipated that the impact on multi-asset strategies would be minimal.
Finance Minister Nirmala Sitharaman has suggested increasing STT on futures from 0.02 percent to 0.05 percent in her Budget for 2026–2027, while increasing STT on options premium and option exercise from 0.10 percent to 0.15 percent. The core of arbitrage strategies—rolling and churning positions—becomes more expensive as a result of the shift.
Why Higher STT Matters for Arbitrage Strategies
In order to profit from price differences, arbitrage funds usually purchase stocks in the cash market and sell futures at the same time. Due to the large volume and frequent rollover of these deals, even little increases in STT might reduce returns.
An annualized effect of around 0.32 percentage points on arbitrage fund returns might result from the further rise in STT, according to calculations provided by Edelweiss Mutual Fund in a Budget note. This is predicated on an average exposure to 70% arbitrage and 20% portfolio turnover.
📉 STT Hike & Arbitrage Fund Returns
- Budget: Union Budget 2026–27
- Futures STT: Increased from 0.02% to 0.05%
- Options STT: Raised from 0.10% to 0.15%
- Key Impact: Higher cost of rolling arbitrage positions
- Estimated Return Hit: ~0.32% annually on arbitrage funds
- Source: Edelweiss Mutual Fund Budget Note
Effect on Returns Compared With Liquid Funds
It counts for a category whose returns are already tightly correlated with liquid fund yields, even if the overall effect may appear small. –
The return gap between arbitrage funds and liquid funds is anticipated to close even further after taxes. According to the report, the post-tax return difference between arbitrage and liquid funds might shrink to around 0.90 percentage points if liquid funds provide approximately 7%, as opposed to more than 1.2 percentage points before.
Taxation Advantage Still Exists
Arbitrage funds are subject to a long-term gain tax of 12.5 percent, while liquid funds are subject to a 30 percent tax.
The steep increase in STT on futures will reduce the yield advantage of arbitrage funds over liquid and ultra-short funds by around 30 basis points a year. Long-term investors are expected to continue concentrating on core equity strategies rather than short-term parking tools, even while arbitrage funds continue to be low-volatility and tax-efficient, according to Anup Bhaiya, founder of Money Honey Financial Services.
📊 Arbitrage Funds vs Multi-Asset Funds
- Arbitrage Funds: Heavily dependent on cash–futures spreads
- STT Sensitivity: High due to frequent rollovers
- Multi-Asset Funds: Driven by equity, debt, gold & alternatives
- Arbitrage Exposure: Around 25% on average
- Return Impact: Only ~0.08% annually from STT hike
- Overall Effect: Multi-asset strategies largely unaffected
Limited Impact on Multi-Asset Allocation Funds
There is less of an effect on multi-asset allocation funds. These strategies usually depend more on directional equity, debt, or alternative methods and are significantly less exposed to pure arbitrage transactions.
For example, the Edelweiss MF shows that the STT rise would have an effect on yearly returns of around 0.08 percent for a multi-asset allocation fund with an average stock arbitrage exposure of approximately 25%.
Long-Term View on Arbitrage Funds
When maintained over an extended period of time, arbitrage funds continue to provide reduced volatility and equity taxation advantages, even if they may provide somewhat lower post-tax returns. Multi-asset funds are still mostly unaffected by the shift.
What effects do arbitrage funds have on taxes?
Since arbitrage funds invest more than 65% in stocks, they are subject to the same taxes in India as equity mutual funds. Long-term capital gains above ₹1 lakh are subject to 10% taxation without indexation, whereas short-term capital gains (kept for less than a year) are subject to 15%. For short-term investors, this makes arbitrage funds more tax-efficient than liquid or debt funds.
What advantages come with making an investment in arbitrage funds?
By taking advantage of price gaps between the cash and futures markets, arbitrage funds provide low-risk returns. Particularly for clients in higher tax rates, they provide superior post-tax returns compared to liquid funds. These funds benefit from equity taxes, offer comparatively consistent returns, and are less volatile than pure equities funds, making them appropriate for short-term money parking.
Can an arbitrage fund have a negative return?
Although it is uncommon, arbitrage funds may go negative under severe market circumstances. Low arbitrage chances, execution risk, or abrupt market volatility may all result in short-term losses. However, compared to equity funds, these funds have less downside risk since they hedge stock exposure and concentrate on price differences. Returns may be flat or slightly negative during brief time periods.
What could be superior than an arbitrage fund?
Depending on your objective, an arbitrage fund may or may not be superior. Equity mutual funds and index funds are superior for larger returns, but they are riskier. Fixed deposits or liquid funds may be more suitable for conservative investors in terms of safety and liquidity. Arbitrage funds are often better for short-term, tax-efficient gains, but diversified stock investments are a better way to build long-term wealth.
In five years, how can 10 lakhs double?
An annual return of around 14–15% is required to double ₹10 lakhs in five years. A diversified stock portfolio, index funds, or equity mutual funds may help achieve this. The secret is to choose growth-oriented investments, remain invested amid market turbulence, and invest systematically. The poor return of arbitrage funds makes them unsuitable for doubling money.
Frequently asked questions
1. What impact does a higher STT have on short-term investors who use arbitrage funds to store money?
Higher STT makes arbitrage funds somewhat less appealing for relatively short holding periods (1-3 months) by modestly reducing net returns. Ultra-short debt funds or liquid funds may sometimes provide comparable post-tax returns for very brief periods of time, even if they still benefit from equity taxes.
2) Will the risk profile of arbitrage funds alter as a result of the higher STT?
No, the risk profile has not altered much. By maintaining opposing cash and futures positions, arbitrage funds continue to manage equities risk. Since STT raises expenses without creating directional market exposure, the effect is mostly on returns rather than risk.
3) Will increased STT result in fewer chances for arbitrage?
Yes, just a little bit. Increased STT may lower cash-futures spreads by discouraging excessive churning in derivatives. However, arbitrage possibilities will not completely vanish since they are more influenced by institutional flows, market volatility, and liquidity than by STT alone.
4) Given the STT rise, should current investors withdraw from arbitrage funds?
Not always. The product nevertheless makes sense for investors in higher tax rates that use arbitrage funds for short-term, tax-efficient allocation. Return expectations should be reduced, however, and depending on the time horizon, options like low-duration debt funds may be assessed.
5) Compared to arbitrage funds, why are multi-asset funds less affected by STT changes?
The main strategies used by multi-asset funds are asset allocation and directional exposure across debt, equities, gold, and other securities. Higher STT has less overall effect since arbitrage techniques make up a lower amount of their portfolio.
Conclusion
particularly for conservative investors, arbitrage funds are a wise option for low-risk, tax-efficient short-term investment. They are not, however, the best option for multiplying money or building long-term wealth. If investors can withstand market volatility and have a long-term perspective, equity-oriented investments such as mutual funds or index funds are more appropriate for better returns over time.
Disclaimer:
This content is for informational purposes only and not investment advice. Market risks apply. Please consult a financial advisor before investing.
