How India's Derivatives Tax Hike Threatens Arbitrage Fund Returns—Aditya Agarwal Weighs In

The Indian government’s recent decision to increase tax rates on stock derivatives is creating significant headwinds for a $36 billion arbitrage fund industry. Announced in parliament this week, the tax reform aims to restrict speculative trading in options markets. Yet the policy’s ripple effects extend far beyond high-risk traders, directly impacting the lower-risk arbitrage strategies that have thrived in volatile market conditions.

Aditya Agarwal, co-founder of Wealthy.in, a wealth management platform, offers crucial insight into why this seemingly targeted measure poses broader challenges. According to Jin10’s analysis, arbitrage funds—which execute spot-futures strategies to capture market inefficiencies—will face compressed margins as transaction costs rise substantially.

The Arbitrage Fund Challenge: Why Lower-Risk Strategies Are Facing Pressure

Arbitrage funds have historically attracted investors seeking stable returns with reduced volatility exposure. These funds capitalize on temporary pricing disparities between spot and futures markets, a strategy considered far less risky than outright speculation. However, the tax increase fundamentally alters the economics of this approach.

The mechanism is straightforward: when trading costs increase, the razor-thin spreads that make arbitrage attractive become even narrower. This compression directly threatens the fund managers’ ability to generate consistent investor returns, forcing many to reassess their operational models.

Aditya Agarwal on Margin Compression: How Transaction Costs Reshape Spreads

Aditya Agarwal emphasizes that arbitrage spreads typically operate within a confined range of 0.6% to 0.8% on a monthly basis. This tight margin leaves virtually no room for increased operational expenses. When tax burdens rise, every additional percentage point of cost eats directly into profits that investors expect to receive.

“Higher transaction costs per trade will significantly compress these already-narrow spreads,” Agarwal explains, highlighting the cascading impact on fund performance. The problem compounds when managers execute multiple daily trades to maintain positioning—each transaction now carries a higher tax burden, multiplying the cumulative drag on returns.

Market Implications: What the $36 Billion Industry Needs to Know

The arbitrage fund sector now faces a critical inflection point. Managers must choose between absorbing the additional tax burden—thereby cutting into investor distributions—or potentially adjusting their investment strategies and fee structures. Some funds may shift toward less tax-efficient trading patterns, while others might explore alternative markets outside India’s regulated framework.

For retail and institutional investors relying on arbitrage funds for portfolio stability, the policy creates uncomfortable choices: accept lower yields, move capital elsewhere, or tolerate higher volatility by shifting to alternative strategies. The $36 billion industry will likely undergo significant consolidation as smaller players struggle with the new cost structure.