Tax Increase Shakes India’s $36 Billion Arbitrage Trade

India’s arbitrage fund managers are bracing for lower returns after the government unexpectedly raised taxes on equity derivatives, a move that threatens a fast-growing sector that holds $36 billion in assets.

The government announced the decision in parliament on Sunday, saying the tax hike was aimed at curbing high-risk speculative trading in the options market. However, arbitrage funds — considered less risky and popular in volatile markets — will also be affected, as the change raises the cost of running cash-and-carry strategies and could dent investor returns.

“Arbitrage spreads are usually narrow, often 0.6%–0.8% per month, and higher transaction ...