THE LEGALITY OF OPTIONS IN SECURITIES

Put and Call options taken under the broad heading of options. The provisions of
Section 16
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of the Securities Contracts Regulation Act 1!"6 #SCRA) and S$%&'s
notification of ())) regulate a contract for the sale or purchase of securities. The
e*pression contract is defined as a contract for or relating to the purchase or sale of
securities.
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+hile the definition of a contract is ,ide in nature as it includes the ,ords
relating to the provisions of Section 16 and the S$%& notification are so-e,hat
narro,er as the. pertain onl. contracts for the purchase or sale of securities. The
/uestion that e-erges fro- this discussion is ,hether options are contracts for the
purchase or sale of securities or ,hether the. are -ere contingent contracts that beco-e
contracts for purchase or sale onl. ,hen the option is e*ercised.
This can be better understood b. distinguishing forward ontrats fro-
options. 0or,ard contracts are fir- arrange-ents for purchase and sale of securities at a
future date at a predeter-ined price. &n such contracts the seller is bound to sell and the
purchaser is bound to purchase ,ith the onl. condition being the lapse of ti-e. 1either
part. is entitled to -ake an. decision ,hether to perfor- the contract and hence a
contract for the purchase and sale of securities can be said to have co-e into e*istence
at the ti-e of e*ecution of the contract itself. 2n the other hand an option is a different
t.pe of contract. An option onl. provides an entitle-ent to purchase or sell securities. An
option holder -a. either e*ercise the option or allo, it to lapse depending on the
circu-stances. A fir- contract for purchase and sale ,hich creates a legall. binding
purchase and sale obligation arises onl. ,hen the option is e*ercised in accordance ,ith
the ter-s of the contract. The obligation to purchase and sell co-es into e*istence upon
the occurrence of a contingenc. ,hich is the e*ercise of the option3 an option can at best
be a contingent contract.
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5ence in this case a contract for the purchase and sale of
securities can be said to co-e into e*istence onl. upon the e*ercise of the option and
not prior to that ,hen the option contract itself is entered into. So long as the transfer is
co-pleted through actual deliver. of securities and pa.-ent of price either on the da.
1
Section 16 6Po,er to prohibit contracts in certain cases7
#18 &f the Central 9overn-ent is of opinion that it is necessar. to prevent undesirable speculation in
specified securities in an. State or area it -a. b. notification in the 2fficial 9a:ette declare that no
person in the State or area specified in the notification shall save ,ith the per-ission of the Central
9overn-ent enter into an. contract for the sale or purchase of an. securit. specified in the notification
e*cept to the e*tent and in the -anner if an. specified therein.
#(8 All contracts in contravention of the provisions of sub;section #18 entered into after the date of the
notification issued there under shall be illegal.
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SCRA Section (#a8.
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A contingent contract is defined in the Contract Act 1<=( Section 41 as a contract to do or not to do
so-ething if so-e event collateral to such contract does or does not happen. &n this conte*t an argu-ent
could be raised that an option contract does not fall ,ithin this definition because the contingent event is
not collateral to the contract but is based on the act of one of the parties to the contract na-el. the e*ercise
of the option. &t has been observed that in order to constitute a contingent contract the happening of the
event -ust be be.ond the control of the parties. That line of argu-ent ho,ever is not relevant as that
pertains to /uestions regarding the for-ation and enforce-ent of contingent contracts as a -atter of
contract la, ,hile the issue relevant for the purposes of this article is ,hether such contracts fall ,ithin the
proscription of Section 16 and the S$%& notification.
the option is e*ercised or the follo,ing da. it should /ualif. as a spot deliver. contract
and therefore per-issible ,ithin Section 16 of the SCRA and the S$%& notification.
According to this anal.sis a for,ard contract ,ill fall ,ithin the proscription of Section
16 of the SCRA and the S$%& notification ,hile an option should sta. outside their
scope.
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The above anal.sis has been sub?ect to ?udicial verification. &n the earl. case of !"t#a$a$
C% T#a&&ar '% R%N% (ap)r
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the %o-ba. 5igh Court ,as concerned ,ith a contingent
contract for sale and purchase of securities and ,as re/uired to decide upon the validit.
of such a contract under the provisions of the %o-ba. Act. &n holding that a contingent
contract did not fall ,ithin the -ischief of the %o-ba. Act the Court reasoned as
follo,s6
4. ... &t is clear on a plain reading of this contract that no obligation attached ,ith regard
to the purchase of these shares on the part of the defendant until the contingenc.
conte-plated occurred after the lapse of 1( -onths. A clear destination -ust be borne in
-ind bet,een a case ,here there is a present obligation under a contract and the
perfor-ance is postponed to a later date and a case ,here there is no present obligation
at all and the obligation arises b. reason of so-e condition being co-plied ,ith or so-e
contingenc. occurring.
>. The contract before us falls into the second categor.. At the date ,hen the contract ,as
entered into there ,as no present obligation ,ith regard to the purchase and sale of the
Shares.
The obligation contingentl. undertaken b. the defendant to purchase the shares onl.
ripened into a perfect obligation at the end of the .ear ,hen the contingenc. took place.
Therefore it is onl. at the end of the .ear that there ,as a contract of purchase or sale
and ,hen ,e look at the ter-s of that contract at the end of the .ear it is clear that the
contract ,as to be perfor-ed i--ediatel. or ,ithin a reasonable ti-e.
The contract ,ould definitel. have co-e ,ithin the -ischief of the Act if the parties had
provided that after the contingenc. occurred the perfor-ance ,as to be postponed for a
particular ti-e. %ut that the parties have not provided for@@.
Appl.ing the Court's anal.sis of a contingent contract an option ,ould beco-e a
contract for purchase and sale of securities onl. ,hen the option or the ri*#t #not the
obligation8 is e*ercised.
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$ven at a basic te*tual level there is a significant difference bet,een a for,ard contract and an option. A
for,ard contract is outla,ed under A16 and the S$%& notification as a contract for purchase and sale of
securities. An option is ho,ever defined in a different -anner as contract for the purchase or sale of a
right to bu. or sell securities in future @ SCRA Section (#d8 Be-phasis suppliedC. &n other ,ords ,hile
a for,ard contract the sub?ect -atter of sale and purchase is the securities involved in an option the sub?ect
-atter is onl. the right to bu. or sell the securities. The nature of the right is dra-aticall. altered depending
upon ,hether the transaction is a for,ard contract or an option
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A&R 1!"6 %o- =>