Section 20 of the Securities Contracts (Regulation) Act 1956 ("SCRA"), prohibited options on securities. After a 1995 amendment, however, the concerned provision has been deleted. Does this mean that the prohibition on options in securities is no longer there? Or does it mean that options on securities are prohibited following the Securities and Exchange Board of India circular of March 1, 2000 ("2000 SEBI Circular") and the Government of India notification of June 27, 1969 ("1969 GoI Notification")?

Unfortunately there is no clear-cut answer. Good arguments can be made on both sides and the absence of a definitive judicial precedent only adds to the ambiguity.

The 2000 SEBI Circular read with the 1969 GoI Notification in effect says that contracts for the sale or purchase of securities are prohibited, except if they are: (a) spot delivery contracts; (b) contracts for cash; (c) hand delivery; (d) special delivery; or (e) contracts for derivatives permissible under the SCRA or the Securities and Exchange Board of India Act, 1992 rules and regulations.

Since the 1969 Government Notification continues to be in force and SEBI has in its 2000 Circular clarified the position to prohibit options on securities other than the stated exceptions, there exists a contradiction between the 1995 Amendment to the SCRA and the 1969 GoI notification and the 2000 SEBI Circular.

Permissive?
The first major argument for allowing options on securities is that of legislative intent. It is logical to argue that the deletion of Section 20 and the phrase "prohibiting options" from the preamble of the SCRA reflects a clear intent of the legislature in favour of permitting 'options in securities'.

This is further reinforced by the Statement of Objects and Reasons of the Amending Act, which specifically provided that it has become essential to amend the SCRA to "facilitate the issuance and trading of options in securities" to enable SEBI to function more effectively.

Second, unlike the 1969 GoI Notification, the 2000 SEBI Circular specifically has a provision that allows a "contract for derivatives as is permissible under the [SCRA] or the [SEBI Act] and the rules and regulations". According to the definition in the SCRA, contracts for derivatives includes 'options' contracts.

This wording from the 2000 SEBI Circular may be read to infer that unless specifically prohibited under the SCRA or SEBI or rules and regulations, all options contracts would be considered valid and enforceable. Consequently, it can be argued that in the absence of an express prohibition on options contracts, all options contracts are valid.

An alternative understanding could be that only those derivatives contracts that are specifically permitted are allowed. The wider all-inclusive reading of the 2000 SEBI Notification would render the provision superfluous, because if express provision was already provided in the SCRA or the SEBI Act or Rules, then seeking permission under a SEBI Circular would not make any sense. Also, the 2000 Circular made only one material change from the 1969 Notification: the addition of 'contracts for derivatives' and it is unlikely that this was just a superfluous change.

Banned?
On the other hand, there are equally persuasive arguments to suggest that options on securities would not be allowed beyond the ones which have been expressly permitted in the 2000 Circular.

Firstly, the Statement of Objects and Reasons of the 1995 Amendment clarify that the idea behind the removal of Section 20 was not to permit option contracts without any regulation.

The regulation of such contracts was left in the able hands of SEBI under Section 16 of the SCRA, and SEBI being of the opinion that at this stage of development of the Indian market, option contracts would result in 'undesirable speculation', had decided to restrict the scope of the same in – see the 2000 Notification.

Secondly, in 1999 via an amendment ("1999 Amendment") the legislature considered it necessary to introduce Section 18A in the SCRA to provide for the legality and validity of exchange traded derivative contracts (including options).

If options and futures were already permitted under the SCRA and the notifications, there would be no need to introduce such a provision by this amendment.

Also, the L.C. Gupta Committee Report of March 1999 (based on which the 1999 Amendment to SCRA was introduced) expressly states that "…The Committee also recommends that the notification issued by the Central Government in June 1969 under Section 16 of the SCRA be amended so as to enable trading in futures and options."

This indicates a view that prior to the amendment of the SCRA in 1999, option contracts in any form were not permitted.

The 2000 Circular, while referring to 'contracts for derivatives', specifies that only such are valid that take place under the SCRA or the SEBI Act / rules and regulations and the rules, regulations and bye-laws of a recognised stock exchange.