In India arbitrage funds manage close to ₹2,78,128 crore as of December 2025. That is a substantial AUM. It has been largely driven by the returns and tax benefits, which score points over liquid funds and bank deposits. An arbitrage fund buys equities and sells equivalent futures on the same stock (in multiples of F&O lots). The spread is the return for the arbitrage fund, which is then passed on to the investor. If you look at the typical arbitrage fund in India, they have given 6.8% to 7.3% over the last 1 year. Since they are classified as equity funds, the capital gains are taxed at 12.5% after taking the basic exemption of ₹1.25 lakhs into consideration. Returns plus tax treatment is the edge. 

In the recent budget presented on February 01, 2026, the rates of securities transaction tax (STT) was raised sharply on futures and options. On futures selling, the rate of STT was raised from 0.02% to 0.05%, an effective hike of 150%. In the case of options selling, the rate of STT was increased from 0.10% to 0.15%. The rate of STT on options delivery was also increased. The options may not matter much as they are on premium value and the arbitrage funds use less of options and more of futures. Also, in the case of futures, the STT is imposed on the notional value, which is what makes it much harder on arbitrage funds. A 150% hike in the STT rate on futures is surely going to hurt. 

We have seen that an arbitrage position is created by the fund by buying in equities and selling equivalent futures. The bigger question is how do they book gains on these arbitrage positions, and how the locked returns are realized. There are 3 ways.  The first is to reverse the arbitrage position when it goes into discount. That is an opportunity that only comes once in a while. The second way is to let futures position expire and leave equity position for selling in the last 30 minutes VWAP. This can be influenced by market volatility and by large orders. The most popular way is to roll over short futures by selling current month and buying next month. This has a large STT cost component. 

That is the million-dollar question. Will this move impact the flows into arbitrage funds? As per early estimates, the cost impact of the higher futures STT on an arbitrage position would be between 35 bps and 40 bps. Where your returns are under 7%, that makes a big difference. For now, the returns are still attractive and tax benefits are a big plus. Things could change if this leads to a fall in arbitrage volumes in the market. Then the arbitrage spreads could narrow substantially. Today, arbitrage spreads are much higher than the historic averages. If spreads trend lower, then investors in arbitrage funds may have second thoughts, considering the risk. That is the big challenge for arbitrage funds!