Archive for category: PIT

– Payal Agarwal and Saloni Khant | corplaw@vinodkothari.com

Designated persons, being insiders with regular privileged information flow, cannot be doing what other investors can do. Several option trades may be devices to skim short term swings in share prices. can designated insiders do these? This interesting question, mostly ignored in Indian corporate practice, is explored in this article.

Derivatives trading is becoming increasingly popular in India, including amongst the retail investors. A recent address by SEBI’s Chairman urges the retail investors to assess their risk capacity while dealing in derivatives and avoid speculative trades. A July 2025 study by SEBI on trading activity of investors in Equity Derivatives Segment (EDS) indicates a relatively very high level  of trading  in  EDS, as compared to other markets, particularly in index options. Further, within EDS, options segment (in premium terms) has shown growth at the fastest rate with average daily premium traded growing at the CAGR of 72% for  index options and 54% for single stock options.

Given the large volumes of derivatives trading, in addition to the concerns on loss of investor’s money (nearly 91% of individual traders incurred net loss in EDS in FY 2025), it is also important to examine the concerns which would arise from an insider trading perspective. Pertinent questions would be whether derivatives trading also comes within the purview of insider trading, and if the answer to this is yes, whether it will also attract the prohibition around contra-trade, where the market participants bet on the short-term future value of the underlying assets to make a profit.

This article examines the aforesaid questions in the light of extant laws, and global position.

Prohibition on insider trading

The prohibition on insider trading comes from Section 12A of SEBI Act –

“No person shall directly or indirectly—

(d) engage in insider trading;”

Reg. 4(1) of PIT Regulations applicable universally to all insiders, also puts a blanket prohibition on trading when in possession of UPSI:

“No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information:”

Para 4 of Schedule B (model CoC for listed entities) specifically pertains to trading by Designated Persons (DPs). They can trade subject to compliance with the Regulations – which provide for monitoring through the concept of “trading window” that is, during which a DP can be reasonably expected to have access to UPSI. Therefore, at such times, the trading window is closed, and the DP cannot trade in securities of that company. When the trading window is open, trading can take place after getting pre-clearance from the Compliance Officer.

In case of a fiduciary, the monitoring happens through a grey list. The concerned persons have to take preclearance from the Compliance Officer. Here, trading restrictions are applicable for securities of such listed companies, for which the person/s is/are acting as fiduciary.

Derivative trading vis-a-vis insider trading norms in India

Prohibition on derivative transactions under 1992 Regulations  

In India, the concept of contra trade was first discussed in a Consultation Paper issued on 1st January, 2008 by SEBI. Pursuant to the proposals made in the Consultation Paper, the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008 was notified, incorporating contra trade restrictions to the insider trading rules of India for the first time, in the following manner:

“4.2 All directors/ officers/ designated employees who buy or sell any number of shares of the company shall not enter into an opposite transaction i.e. sell or buy any number of shares during the next six months following the prior transaction. All directors/ officers/ designated employees shall also not take positions in derivative transactions in the shares of the company at any time.”

Thus, under the 1992 Regulations, there was a complete and explicit prohibition on derivative transactions for designated employees. Note that the ban was for “any time” and not restricted to only while in possession of UPSI.

Position under the 2015 Regulations

While the contra-trade restrictions have been retained in the existing (2015) Regulations, the provision explicitly calling for blanket prohibition on derivative transactions was omitted. The Sodhi Committee Report does not contain any specific discussions in this regard.

Nonetheless, derivatives, qualifying the definition of “securities”, continue to be covered by the insider trading regulations. Reg 6(3) of the 2015 Regulations specifically refers to trading in derivatives, for the purpose of disclosure of trading in securities. 

The  disclosures  of  trading  in  securities  shall  also  include  trading  in  derivatives  of securities and the traded value of the derivatives shall be taken into account for purposes of this Chapter.

As regards the value of derivatives for such disclosures, the same refers to the “traded value” of the derivatives. The format for such disclosures, as specified in the SEBI Master Circular on Surveillance of Securities Market (Annexure – I), also refers to disclosure of trading in derivatives on the securities of the company, and requires calculation of notional value of options based on premium plus strike price of the options.

Further, trading in equity derivative instruments i.e. Futures and Options of the listed company are covered by the system driven disclosures [Para 3.3.3. of the SEBI Master Circular].

Further, the Guidance Note on SEBI (Prohibition of Insider Trading) Regulations, 2015 dated 24th August, 2015 currently forming a part of the SEBI FAQs on PIT Regulations dated 31st December, 2024, includes the following:

52. Question

Whether the immediate relative of the designated person can trade in the derivatives of the company?

Answer

Yes.  Designated  person  and  its  immediate  relative  can  trade  in  derivatives  when  not  in possession of UPSI and such trades are accordingly governed by the code of conduct.

Thus, the following points may be noted –

• A person cannot undertake insider trading in securities – directly or “indirectly”. Derivatives are defined under  Section 2(ac) of the Securities Contracts (Regulation) Act, 1956.

“Derivative”—includes

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices,  of underlying securities;

(C) commodity derivatives; and

(D) such  other  instruments  as  may  be  declared  by  the  Central  Government  to  be derivatives;

Therefore, trading in derivatives may technically tantamount to trading in underlying securities – indirectly. This is irrespective whether the transaction results in actual delivery or is only net-settled in cash.

• The definition of “securities” includes derivatives – hence, there should not be any confusion as to why trading in derivatives of the underlying securities should be excluded from the scope of “trading”
• Chapter III of PIT Regs. which is applicable to all insiders (note, that DPs are closest insiders), explicitly says that trading in securities includes trading in derivatives.
• SEBI FAQ (Q. 52 above) makes it clear that trading in derivatives is only possible when the DP/ immediate relative is not in possession of UPSI^[1]. Of course, whether or not the DP/immediate relative is having possession of UPSI or not, is to be seen at the time the trading is proposed to be done.

Therefore, what is clear is that unlike the 1992 Regulations, there is no explicit provision calling for blanket prohibition on the derivative transactions by DPs and their immediate relatives. However, restrictions as are applicable otherwise in relation to securities of a listed company, would also apply to derivatives having such securities as underlying. Of course, the restriction is not a blanket prohibition as was in 1992.

In simple terms, a derivative should be treated no differently than the underlying security itself. Consequently, in view of the author:

• When the trading window is closed, a DP should not be allowed to enter into a derivative in securities as well.
• When the trading window is open, trading in derivatives should be subjected to preclearance.

The above position is also apparent in other jurisdictions, where, in the context  of insider trading norms, dealing in derivatives is equivalent to dealing in underlying securities.

Once it is clear that trading in derivatives is equivalent to trading in underlying security, then it is obvious to conclude that trading in derivatives will also be governed by contra-trade prohibition in the same manner as trading in the underlying itself. See detailed discussion below.

Issues concerning contra-trade

Rationale for prohibiting contra-trade

The insider trading norms around the world prohibit contra trade or short swing trades by the persons privy to or likely to be privy to unpublished price sensitive information (UPSI) about the listed securities. The SEBI (Prohibition of Insider Trading) Regulations, 2015 restricts the Designated Persons (DPs) and their immediate relatives from undertaking reversal trades, within six months from undertaking the previous trade transaction. The intent is to prevent the abuse of UPSI by making short-term profits through unfair means.

The 2008 Consultation Paper states, “It is assumed that insiders have a long term investment in the  company and are not expected to make rapid buy/sell transactions, which are assumedly based on at  least some level of superior access to information, whether material or not.”

Hence, whenever there is a contra-trade within a short span of time (6 months), there is a presumption that the said trade is based on some “superior” access to information – as such, contra-trades are simply prohibited. The DP cannot undertake a contra-trade even if it is contended that he does not have UPSI.

Contra-trade in case of derivatives

Naturally, a question arises on whether DPs can trade in derivatives, and if so, when does the same qualify as contra-trade or otherwise, and the consequences that follow. Let’s take a simple illustration – Mr. A, a DP of X Ltd. purchases 100 shares of X Ltd. on 1.11.2024. Then purchases a put option on 15.11.2024, for all 100 shares. On 01.02.2025, on maturity of the put option, A exercised the put option and sold all the 100 shares. All these transactions, as one would note, are happening within a period of 6 months. The question is – whether A was allowed to undertake the 2nd transaction of purchasing a put option within 6 months of the 1st transaction. 

There is a question appearing in SEBI FAQ, as follows:

37.Question

In case an employee or a director enters into Future & Option contract of Near/Mid/Far month contract, on expiry will it tantamount to contra trade? If the scrip of the company is part of any Index, does the exposure to that index of the employee or director also needs to be reported?

Answer

Any  derivative  contract  that  is  physically  settled  on  expiry  shall  not  be  considered  to  be  a contra  trade. However,  closing  the  contract  before  expiry  (i.e.  cash  settled  contract)  would mean taking contra position. Trading in index futures or such other derivatives where the scrip is part of such derivatives, need not be reported.

This question above clearly deals with treatment of expiry of a derivative contract or settlement of a derivative contract as to whether those events would be treated as contra-trade. That is, a culmination of a derivative contract, resulting in the delivery of the underlying will, of course, not amount to a separate “trade” – therefore, there is no question of a contra-trade. On the other hand, where no physical delivery is taken, rather, settled in cash (payment of the difference between the contract’s entry price and market price at expiry), the same amounts to a “sell” trade, thereby, a reversal of the position of the DP.  Thus, where the contract is proposed to be settled prior to expiry, it would result in a different transaction/trade – thus, it should be treated as a contra-trade.

Now, if seen in a practical context, in India, the validity of derivatives contract would usually be less than 6 months (typically 1-3 months^[2]). And, typically, these derivative transactions in such cases are net-settled before expiry, rather than culminating in actual delivery of securities^[3]. Options enable the investors to speculate in shares of higher values and volumes as compared to the cash segment since the only amount payable would be the premium and the net difference in the strike price and spot price later on. Further, cash settlement in derivatives provides a higher leverage to the trader.

In the above scenario, there will always be a higher possibility of a contra-trade. The illustrations below explain the same:

S. No	Transaction	Remarks (assuming T1 and T2 happen within a period of 6 months)
1	T1 – Buy call option T2 – Cash settlement	Contra trade. Buying call option is equivalent to a “buy” transaction. Subsequent cash settlement indicates a “sale” transaction.
2	T1 – Buy call option T2 – Physical settlement	Not a Contra trade. Buying call option is equivalent to a “buy” transaction, subsequent physical settlement only results in delivery of such shares.
3	T1 – Buy call option T2 – Expiry of option on account of out-of-the money	Not a Contra trade. Buying call option is equivalent to a “buy” transaction, however, did not result in delivery on account of the strike price > market price at the time of expiry.
2	T1 – Sell call option T2 – Cash settlement	Contra trade. Selling call option is a “sale” transaction. Cash settlement indicates a “buy” transaction.
3	T1 – Buy put option T2 – Cash settlement	Contra trade.  Buying put option is a “sale” transaction. Not taking physical delivery of the shares and carrying out cash settlement indicates a “buy” transaction.
4	T1 – Sell put option T2 – Cash settlement	Contra trade. Selling put option is a “buy” transaction. Cash settlement is deemed to be a “sale” transaction.

As such, trading in derivatives would be much more vulnerable to chances of insider trading, than actual trading in securities. Hence, it becomes extremely important to put mechanisms in place to ensure that derivatives trading be subjected to enhanced restrictions and controls, as suggested below.

Enhanced safeguards in respect of derivative transactions by DPs

It is quite clear that a derivative transaction that results in cash settlement construes a contra-trade. On the other hand, where physical delivery is taken (although it is not very common to close a derivative contract in physical settlement), the derivative transaction is not considered as a contra-trade (although the same is also to be matched against the previous trade in cash segment). Therefore, in order to ensure that the trade does not result in contra-trade, it is essential that the derivative is either settled by delivery or simply expires on the maturity date, and that there is no cash settlement.

In order to ensure this, in case of purchase of options (put/ call) by the DP, pre-clearance may be provided by the Compliance Officer subject to receipt of a declaration that the DP shall necessarily undertake physical settlement of such trades at the maturity date. Of course, there would be no concerns in case of an out-of-the money option, that is, where prior to the expiry of the contract, the market price remains below the strike price. An out-of-the money option does not result in any profits in the hands of the option holder, however, prevents additional loss in the face of exercising an option where the strike price at which the option is exercised and shares are acquired is higher than the current market price at the time of such exercise of option (upon maturity of the contract).

On the other hand, in case of sale of options (put/ call) by the DP (that is, where the DP is the writer of the option), the physical settlement cannot be guaranteed by the DPs, and chances of contra-trade are higher, as the counterparty (that is, buyer of the option) may choose to have cash settlement before the expiry of the derivative contract. Therefore, in order to obviate the possibility of a contra-trade happening, it might be necessary to completely prohibit sale/writing of options by DPs. This prohibition may be enabled through the code of conduct. . In fact, it is seen that  several large listed companies have put a blanket prohibition on derivative transactions by DPs and their immediate relatives.

Contra-trade where there is a preceding/succeeding trade in securities

Besides, this FAQ does not deal with a scenario where a DP who has traded in securities already, now proposes to enter into a derivative contract within a span of 6 months from the date of original contract.

However, one thing is clear from this FAQ – the very entering into the derivative contract (and not expiry/maturity thereof) has been considered to be a trade by SEBI. Also, as discussed in the first part of this article, trading in derivatives should be considered as trading in securities itself. As such, if there has been a trade in securities, and there is a subsequent trade, although in derivatives of those very securities, it would result in contra-trade. That is, if in the above example, A enters into a “put option” – then he will have the right but not the obligation to “sell” the underlying shares, within 6 months of buying the shares. Whether to actually “sell” or have a concrete “right to sell” at a future date at or above a given price – it is nothing but a clear case of “contra-trade”.

For instance, assume a DP purchases shares of the listed company on 1.1.2025. Subsequently, on 1.3.2025, the DP purchased a put option. The put options, akin to a sale transaction, results in contra-trade when matched against the previous “buy” transaction in the cash segment, within a gap of less than 6 months between the two transactions. Similarly, where a call option is bought within 6 months of a previous sale transaction, the same results in contra trade.

Compliances in relation to trading in derivatives by DPs

(1)   Appropriate mechanisms in the Code of Conduct

Prior to making trades in the derivatives, it is important for the DP to ensure that the Code of Conduct does not prohibit such trades. Unless expressly prohibited, the Code of Conduct may contain necessary clauses as discussed above, in order to enable derivative trading by DPs, subject to enhanced controls on the same.

(2)   Manner of identification of derivative trades

The trading in equity derivative instruments i.e. Futures and Options of the listed company are covered by the system driven disclosures [Para 3.3.3. of the SEBI Master Circular]. Hence, an instance of contra trade through derivative instruments is easily identifiable by the Compliance Officer.

(3)   Pre-clearance for the purpose of trading

Not all trades of DPs are pre-cleared by the Compliance Officer. The pre-clearance is required only for such trades that exceed the thresholds provided in the CoC of the respective listed entity, generally Rs. 10 lacs or more. Here, the value of trade becomes important, and cannot be just limited to the premium payable/ receivable at the time of purchase/sale of such contract. The price of the securities is also relevant. Pre-clearance may be granted by the Compliance Officer, subject to such conditions and undertaking as suggested above.

(4)   Trading during closure of trading window

The DPs cannot trade in the derivatives of a company’s securities during the trading window closure period. In order to ensure the trades are not done during the trading window closure period, the concept of freezing of PAN has been introduced – both at the level of the DP as well as their immediate relatives (see an article here). However, the freezing of PAN is applicable only to the quarterly TW closure pending announcement of financial results.

The DP to ensure that neither him, nor his DPs trade in the derivatives of the company during the closure of trading window period.

(5)   Reporting of trades in derivatives

As regards the reporting of trade in derivatives, the SEBI Master Circular provides guidance on calculation of notional value of trades, to be calculated based on premium plus strike price of the options. The disclosure of trades are primarily system-driven, based on the PAN details of the DPs updated with the designated depository. Having said that, in case of trades of the immediate relatives of the DPs, or where the PAN details are not updated with the depository, manual disclosures are required for such trades.

(6)   Consequences of violation – disgorgement of profits and penal actions

A breach of contra trade restriction leads to disgorgement of profits made and its remittance to SEBI for credit to IPEF. Here, the question arises on what is considered the value of profits for disgorgement to IPEF, in the context of derivatives.

Where the transaction pertains to ‘sale’ of options, the profits would usually be the premium earned by the seller of options. On the other hand, in case of ‘purchase’ of options, the profits should be the difference between the buy and sale value, net of other expenses in connection with such option contracts.

Guidance may also be taken from  17 CFR § 240.16b-6(d) of the SEC Act, which states that the amount of profit shall be calculated as the profits that would have been realized had the subject transactions involved purchases and sales solely of the derivative security valued as of the time of the matching purchase or sale, and calculated for the lesser of the number of underlying securities actually purchased or sold. The amount of such profit shall not exceed the premium received for writing the option.

In addition to disgorgement of profits, penalty may also be levied. For instance, in an adjudication order dated 29th April 2022, the purchase and sale of options on consecutive days resulted in contra trade violation attracting a penalty of Rs. 2 lacs.

Global view on contra-trade in derivatives

Section 16(b) of the Securities and Exchange Commission Act, 1934 of the USA, restricts contra trade in equity securities, for a beneficial owner holding more than 10% of any class of any equity security, director and officer, including a security-based swap agreement involving any such equity securities.  Exemptions have been prescribed for derivative transactions in certain cases in CFR § 240.16b-3 of the General Rules and Regulations.

The General Rules and Regulations of the SEC provides detailed guidance on when a derivative trade qualifies as a short swing trade and vice versa. The same has been summarised here:

• Transactions that qualify as “purchase” of underlying securities:
  • establishment/ increase of a call equivalent position
  • liquidation/ decrease of a put equivalent position
• Transactions that qualify as “sale” of underlying securities:
  • establishment/ increase of a put equivalent position
  • liquidation/ decrease of a call equivalent position
• Transactions that are exempt from short swing restrictions:
  • increase/ decrease pursuant to fixing of the exercise price of a right initially issued without a fixed price, where the date the price is fixed is not known in advance and is outside the control of the recipient
  • Closing as a result of exercise or conversion of the option, that is, 
    • Acquisition of underlying securities at a fixed exercise price due to the exercise or conversion of a call equivalent position
      • Except in case of out-of-the money option, warrant or right
    • Disposition of underlying securities at a fixed exercise price due to the exercise of a put equivalent position.
  • Where the person trading is not a major beneficial holder, and thus, an insider, at the time of both the transactions which are being termed as contra trade [Section 16-b of SEC Act].
  • Other exemptions apply w.r.t. transactions with the issuer, subject to certain conditions and transactions pursuant to tax conditioned plans [CFR § 240.16b-6]

Article 164 of the Financial Instruments and Exchange Act, 1948 of Japan also restricts reverse trades in specified securities, by major shareholders and officers etc, who may have obtained secret information in the course of their duty or by virtue of their position. Specified securities, for the purpose of the said provision, include Derivatives [Article 163 r/w Article 2(xix)].

Judicial precedents on contra trade transactions

In Allaire Corporation v. Ahmet H. Okumus, the Circuit Court held that when the option is written by the insider, he has no control over whether the options buyer will exercise the option or square it off. Thus, trade carried out pursuant to selling an option shall not be considered a transaction for the purpose of determining whether a set of transactions is a contra trade or not. The facts of the case involved writing another option within six months of expiry of the first option remaining un-exercised. Note that the expiration of the first set of options does not constitute a purchase matchable to the later sale of a different set of call options. 

However, as clarified in Roth v. The Goldman Sachs Group, Inc., et al., No. 12-2509 (2d Cir. 2014), when matched against its own writing, the expiration of an option within six months is a “purchase transaction” for the purpose of section 16-b.

The danger of misuse of non-public information exists at the time the option is written, and the expiration of that option is the moment of profit.  Matching writings with expirations of different options does not clearly advance the purposes of the statute. Options written at different times are less likely to give rise to speculative abuse, and matching the expiration of an option only to its own writing recognizes the more evident danger.

In Chechele v. Sperling, the Circuit Court held that where pursuant to the settlement of the futures contract, the pledge on shares is revoked, the revocation is not considered to be a ‘purchase’ transaction to be combined with the open market sale of such shares to identify these trades as contra trades.

The exercise of a traditional derivative security is a “non-event” for section 16(b) purposes.

In the case of Macauley Whiting v. Dow Chemical Company, the Court held that where the insider has exercised an option to purchase shares and his spouse has sold shares within a period of 6 months, these transactions shall be considered to be short swing trades (contra trades).

In the context of § 16(a), the Commission has evolved a dual test of an insider’s beneficial ownership of his or her spouse’s shares. Such beneficial ownership may derive from the insider’s “power to revest” in himself title to those shares.[6] Or it may result from his enjoyment of ‘benefits substantially equivalent to those of ownership.’

In the case of Kern County Land Co. v. Occidental Petr. Corp., a person fails in his attempt of a takeover due to a defensive merger carried out by the target company. During the period when the merger was being finalised, the acquirer entered into an option agreement with the transferee company. The option agreement stipulated that if and when the merger succeeds, the transferee company would buy the shares held by the acquirer pursuant to the takeover attempt. The US Supreme Court held that such a set of trades would not result in contra trade because the actions of the acquirer were involuntary.

The option was grounded on the mutual advantages to respondent as a minority stockholder that wanted to terminate an investment it had not chosen to make and Tenneco, whose management did not want a potentially troublesome minority stockholder; and the option was not a source of potential speculative abuse, since respondent had no inside information about Tenneco or its new stock.

Concluding Remarks

In practice, several large listed companies continue to prohibit trading in derivatives by the Designated Persons and their immediate relatives through their Code of Conduct. The regulations do not enforce such blanket prohibition, although no trading can be done that falls foul of other requirements of the Regulations – viz., trading while in possession of UPSI, contra trades, trading during closure of trading window, trading without pre-clearance etc.

Having said that, derivatives, by nature, are short term trades based on the expectations of the movement in price of the securities in a certain direction within a short period of time. Therefore, in case of trades by DPs, the chance of such trades being motivated by an information asymmetry is comparatively higher, thereby potentially resulting in an insider trading allegation on such DP.

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^[1] Annexure VII of  ICSI Guidance Note on Prevention of Insider Trading states “The designated persons and their immediate relatives shall not take any positions in derivative transactions in the Securities of the company at any time.” However, the source of such stipulation is not clear, as currently there is no corresponding provision in PIT Regulations.

^[2] Derivative  contracts are mostly for a tenure of up to 3 months as per standardized contract specifications given on BSE  – https://www.bseindia.com/static/markets/Derivatives/DeriReports/contractindex.aspx

^[3] An article on options trading in India – click here.