It is very important for an Option trader to understand the STT (Security Transaction Tax) applicable in case he does not squares-off the position or if the position is exercised by the exchange for an ITM(In-the-money) option.
Let us take the following two scenarios for better understanding of the STT charges.
Scenario 1: Buy 1 lot of Nifty call option with a strike price of 6000 at Rs.90 and sell it at Rs 100. The STT charged will be Rs 3.75.
(75*100*0.05% = 3.75) i.e. (Quantity * Premium * 0.05%)
Note: STT of 0.05% is charged on the sell side.
Scenario 2: Buy 1 lot of Nifty call option with a strike price of 6000 at Rs. 100 but don’t sell it and let it expire on the last day of the contract.
Now on the day of the expiry if the Nifty Spot closes at 6100, then the call option will be ITM as the Spot price > Strike price & the STT charged will be Rs. 571.87.
(6100*75*0.125%) = 571.87 i.e. (spot price *Qty*0.125%).
Note: STT of 0.125% is charged, where option is exercised by the exchange.
Concept of “Do-not-exercise” option contracts
On the day of Expiry, equity delivery STT will be levied on In-the-Money (ITM) expiring options. To prevent higher STT being levied and to avoid additional risk to the client, fresh option buy position will be blocked in overnight/delivery (NRML product code), Cover Order and Bracket Order on last trading day of contract. The client will however be allowed to square off their existing option positions. Further, client can trade intraday (MIS product code) in options on last trading day of the contract. However, all MIS open positions are subject to auto-square off at or after intraday square-off time.
If the STT levies by the exchange is less than the premium received by the clients then their long ITM options position will be exercised by default. However. if the STT surpasses the premium VNS will go for ‘Do not Exercise’ choice for the Close-To-Money (CTM) options”
Let’s understand with the below example.
Suppose you have purchased Nifty call option with strike price 10000. The settlement price declared on expiry day, by the exchange is 10200. This means the option that you bought is called as In-the-Money(ITM) option and also called as close to money(CTM*) option contract.
*CTM contract: Three strike prices above and below the settlement price are called as CTM contracts. In our example, the settlement price is 10200. Hence call options with strike price of 10150, 10100, 10050 and put options with strike price 10250, 10300, 10350 are called as CTM contracts.
If STT charge is higher than the premium then it will be marked as “Do-not-exercise”. If STT levied is less than the premium then RMS will give intimation to the exchange to exercise the option and respective amount will be credited to the account.
Case 1: When STT applied is higher
Consider you have purchased 1 lot(75 qty) of Nifty ITM call option with strike price 10150 and 10160 settlement price declared by the exchange. If you do not square off the position on the expiry date, the amount would get credited will be Rs. 750 [(10160-10150)*75] then RMS will check what is the STT levied to the transaction. In this case, STT levied is Rs.952.5 (10160*0.125%*75)
Looking at the above example, it is clear that the STT is higher. Hence, RMS will go for “Do-not-exercise” facility and no STT will be debited to your account. You are going to lose only the premium that you paid while buying the contract.
Case 2: When STT applied is lower
Let’s assume you bought 1 lot of Nifty, call option with strike price 10100 and consider the same settlement price of 10160. In this case if you do not square off the position on expiry, you would receive Rs. 4500 [(10160-10100)*75] and the STT charged will be Rs. 952.5 (10160*0.125%*75)
Case 2 is clearly saying that the STT levied is very less than the premium receivable. In this case RMS will give the intimation to exchange to exercise the position from exchange’s end. The amount credited to your account would be Rs. 3547.5 (4500-952.5).