Definition of ‘Option’
A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
Call options give the option to buy at certain price, so the buyer would want the stock to go up.
Put options give the option to sell at a certain price, so the buyer would want the stock to go down.[1]
Purpose which Options Serve
Option contracts is a mechanism which provide the investors with exist opportunities, which in common parlance of commercial practice is important to attract the funding avenues in the form of private equity, venture capital, infusion of more funds from foreign institutional investors, and involvement of even multilateral agencies like the International Finance Corporation.
Call options (right to acquire more shares), and put options (right to sell off the shares) serve as tools to meet the purpose as stated above. Though listing of shares is one of the ways which provides easy liquidity to these investors, yet it has its own dimensions and so, these investors have to look out for other ˜options™ to ensure that they do not fall short of exit routes.[2]
Position Before SEBI™s Notification dated 3rd October, 2013[3]
SEBI on various occasions has clarified that call options and put options are illegal because of the following two reasons
Firstly, these contracts cannot be considered as valid derivative contracts as they can only be traded on stock exchanges and not through private contracts between parties.[4]
Secondly, this privately contracted option gives the parties the right to put or call at a future date which makes it an invalid ˜spot-delivery™ contract under section 2 (i) of SCRA.
The SEBI in its informal guidance note given to Vulcan Engineers Ltd[5] relating to the purchase and sale of shares of the company at a pre agreed price under the PUT/Call Options stated that:
˜As [this] (put / call) option would be exercised in a future date¦the transaction would not qualify as a spot delivery contract under SCRA S. 2(i), nor as a legal and valid derivative contract in terms of S. 18A.™
Also, in the Cairn-Vedanta deal[6] SEBI was of the view that put option and call option arrangements do not conform to the requirements of a spot delivery contract nor with that of a contract of Derivatives as provided under section 18A of the Securities Contracts (Regulation) Act, 1956. Also, put option and call option arrangement along are in violation of Notification No. SO 184(E) dated March 1, 2000 issued by SEBI.
Recent Scenario
SEBI recently, vide its Notification dated October 3, 2013[7], has rescinded the previous notification[8] and treated exercise of option contracts are valid and, if these contracts satisfy the three cumulative conditions set forth in the notification:
i. the title and ownership of the underlying securities is held continuously by the selling party to such contract for a minimum period of one year from the date of entering into the contract;
ii. the price or consideration payable for the sale or purchase of the underlying securities pursuant to exercise of any option contained therein, is in compliance with all the laws for the time being in force as applicable; and
iii. the contract is settled by way of actual delivery of the underlying securities.
i.e. if the underlying securities are disposed of prior to one year or if the underlying securities are not delivered at the time of exercise of the option.
SCRA and SEBI™s Notification
Whether illegality in options can be avoided using Section 18A of SCRA?
Options contracts as derivatives[9] and now are exempted from the scope of Section 18A. So, these contracts fulfilling the stipulated three conditions need not comply with Section 18A. However, even if these contracts do not comply with any of the conditions but comply with Section 18A, these would not be rendered invalid, since fundamentally these contracts have been treated as ˜derivatives™ by the regulator.[10]
Conclusion
This initiative taken by SEBI in the area of Options proves to be investor friendly step and will be welcome by investor in the market and help in the efficient and effective marketability and transferability of securities.
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Bibliography
[1] http://www.investopedia.com/terms/o/option.asp (Last accessed on 28th October, 2013).
[2] http://indiacorplaw.blogspot.in/2013/10/analysis-of-sebi-notification-on-pre_11.html (Last accessed on 28th October, 2013).
[3] Notification No. LAD-NRO/GN/2013-14/26/6667.
[4] § 18A Securities Contract (Regulation) Act, 1956.
[5] Informal Guidance to Vulcan Engineers Ltd., 23rd May, 2011, www.sebi.gov.in/informalguide/Vulcan/sebilettervulcan.pdf (Last accessed on 28th October, 2013).
[6] SEBI Order- In re Cairn Vedanta Deal dated 1st March 2012.
[7] http://www.moneycontrol.com/news_html_files/news_attachment/2013/SEBI%20NOTIFICATION.pdf (Last accessed on 28th October, 2013).
[8] SEBI Notification No. S.O 184(E) (1 March 2000).
[9] Rajshree Sugars and chemicals Ltd. v. Axis Bank Ltd. (2008) 8 MLJ 261.
[10] http://indiacorplaw.blogspot.in/2013/10/analysis-of-sebi-notification-on-pre_11.html (Last accessed on 28th October, 2013).
