NISM-Series-VIII: Equity Derivatives · Legal and Regulatory Environment

Regulation of Derivatives Trading and Eligibility Criteria for F&O

Updated 11 October 2026 · Fact-checked

The L.C. Gupta Committee set the regulatory framework for introducing derivatives in India. The J.R. Varma Committee set risk containment rules, mainly margining. SEBI then allows derivatives only on liquid stocks and broad indices that meet eligibility tests. To answer questions, match each committee to its theme, then apply the criteria.

Understand Regulation of Derivatives Trading and Eligibility Criteria

Before 2000, India had no exchange-traded equity derivatives. SEBI first needed a legal and risk framework. It set up two committees. The L.C. Gupta Committee was constituted in 1996 and reported in 1998. The J.R. Varma Committee was constituted in 1998. NISM questions often test which committee recommended what.

The L.C. Gupta Committee dealt with the regulatory framework. It recommended that derivatives be introduced in phases, starting with index futures, then index options, then stock options and stock futures. It wanted derivatives traded on exchanges, not over the counter. It also wanted the law to treat derivatives as securities. The Securities Contracts (Regulation) Act was amended in 1999 so that derivatives were included in the definition of securities. That made them legal and regulated under the SCRA, with trading on recognised stock exchanges.

The committee also recommended a separate derivatives segment or exchange with its own governance and a separate clearing corporation. It recommended a minimum net worth for clearing members. The exact figure is set by SEBI and the exchange, so verify it against your workbook. Dealers and sales staff needed a minimum certification, which is why you take this NISM exam.

The J.R. Varma Committee dealt with risk containment. It recommended that initial margins be based on Value at Risk (VaR) at a 99% confidence level over a one-day horizon. Volatility is estimated with an exponentially weighted method. It also recommended portfolio-based margining, daily mark-to-market, and a minimum margin on short option positions. Think of it this way: Gupta decides who may trade and under what structure. Varma decides how much money must be held against the risk.

Index futures started in June 2000, index options in June 2001, stock options in July 2001 and stock futures in November 2001. The order matches the Gupta phasing. Finally, SEBI allows contracts only on eligible stocks and indices. These need adequate liquidity, market depth and size so that prices cannot be easily manipulated. The exact numeric thresholds are revised by SEBI from time to time, so learn the criteria as set out in your workbook edition.

Key formulas to remember

Gupta Committee phasing: Index futures → Index options → Stock options → Stock futures; This is the order in which products were introduced. Stock futures came last in actual launch.
Legal basis: SCRA amendment (1999): derivatives included in the definition of 'securities'; This made derivatives legal and regulated under the SCRA. Trading takes place on recognised stock exchanges.
Gupta clearing member net worth: Clearing members need a minimum net worth (recommended by the committee; figure set by SEBI and the exchange); This was a recommendation. The actual figure is set by SEBI and the exchange, so verify it against the workbook.
Varma margining basis: Initial margin = 99% VaR, one-day horizon; Add daily mark-to-market. A minimum margin applies to short options.
Stock eligibility tests: Eligible stock = meets SEBI tests on market capitalisation and traded value rank, order-size liquidity, market-wide position limit and delivery value; Numeric limits change over time. Know the tests and use the workbook values.
Index eligibility tests: Eligible index = enough constituents, no single stock or few stocks dominating the weight, and constituents mostly F&O-eligible; Numeric limits change over time. Learn the concentration and constituent-count idea.

How to solve Regulation of Derivatives Trading and Eligibility Criteria questions

Use this method for any question on derivatives regulation, committees or eligibility.

1Read the question stem and underline the theme: legal framework, structure, risk or margin, product sequence, or eligibility.
2If the theme is legal framework, governance, clearing corporation, net worth or phasing, think L.C. Gupta.
3If the theme is margins, VaR, mark-to-market or risk containment, think J.R. Varma.
4If the question asks about product order, recall index futures, index options, stock options, stock futures.
5For eligibility, ask what the criterion measures: size, liquidity, concentration or delivery. Then check which option matches.
6Remove options that mix up the two committees or reverse the product order.
7Watch for words like 'only', 'always' and 'all'. Pick the option that matches the stated rule exactly.
8If a numeric limit appears, choose the option consistent with the workbook figure, not one you half-remember.

Quickest way: Committee-theme shortcut

When to use it: Use when you have under a minute and the options name committees or recommendations.

Gupta = structure and law: SCRA, separate segment, clearing corporation, net worth, phasing, certification.
Varma = risk: VaR, margins, mark-to-market.
For eligibility, pick the option that stresses liquidity and resistance to manipulation.
Reject any option that puts stock futures first or calls derivatives unregulated.

Common mistakes in Regulation of Derivatives Trading and Eligibility Criteria

Attributing VaR-based margining to the L.C. Gupta Committee.
Both committees dealt with derivatives and were set up within a few years of each other, so students blur them.
Fix: Link Gupta with the regulatory framework and Varma with risk containment. Recall VaR as Varma's 'V'.
Saying stock futures were introduced first.
Stock futures are popular today, so students assume they came early.
Fix: Remember the order: index futures, index options, stock options, stock futures.
Memorising old numeric eligibility limits as fixed.
Notes copied from old sources show figures that SEBI has since revised.
Fix: Learn the logic of each test, and check the numbers against your current workbook edition.
Thinking the SCRA amendment created exchanges or the clearing corporation.
Students over-read the amendment's role.
Fix: The amendment included derivatives in the definition of 'securities' so they could be legal and regulated under the SCRA. Structure came from the Gupta recommendations and exchange rules.
Believing any listed stock or any index can have derivatives.
Students confuse being listed with being eligible.
Fix: Listing is only a starting point. A stock or index must also pass SEBI's liquidity, size and concentration tests.
Assuming derivative contracts are based on OTC trading under Gupta.
Students mix the general idea of derivatives with the Indian rules.
Fix: The framework is built around exchange-traded contracts, cleared and guaranteed by a clearing corporation.

Worked examples

Example 1

Which of the following correctly describes the phased introduction of equity derivatives recommended by the L.C. Gupta Committee? (A) Stock futures, stock options, index futures, index options (B) Index futures, index options, stock options, stock futures (C) Index options, index futures, stock futures, stock options (D) Stock options, stock futures, index options, index futures

Show the solution

The theme is product sequence, so this is a Gupta Committee question.
The recommendation begins with index products, because an index is broad and hard to manipulate.
Within index products, futures come before options.
Stock-based products follow, with stock options before stock futures.
This matches the actual launches: June 2000, June 2001, July 2001 and November 2001.
Only option B has this order.

Answer: (B) Index futures, index options, stock options, stock futures.

Example 2

The J.R. Varma Committee recommended that initial margin for derivatives be based on which approach? (A) Fixed 100% of contract value (B) Value at Risk at a 99% confidence level over a one-day horizon (C) Book value of the member's assets (D) The previous day's closing price only

Show the solution

The theme is margins and risk containment, so this is the Varma Committee.
Varma's key idea was risk-based margins using VaR, not a flat percentage.
The confidence level was 99% and the horizon was one day.
Option A would lock up too much capital and is not risk-based.
Options C and D do not measure potential loss on the position.
Daily mark-to-market is added separately, but the question asks about initial margin.

Answer: (B) Value at Risk at a 99% confidence level over a one-day horizon.

Exam tips

Make a two-column list: Gupta (law, structure, phasing, net worth, certification) and Varma (VaR, margins, mark-to-market). Most committee questions are answered from it.
Memorise the launch order with dates: June 2000, June 2001, July 2001, November 2001.
For eligibility, know what each test is meant to achieve. Options that talk about liquidity and manipulation resistance are usually right.
Treat numeric limits carefully. Use the figures in your current NISM workbook and do not rely on older notes.
Watch for options that swap the committees. Check the theme before looking at the details.

Practice questions from Legal and Regulatory Environment

Regulation of Derivatives Trading and Eligibility Criteria: frequently asked questions

What did the L.C. Gupta Committee recommend on derivatives?

It recommended introducing derivatives in phases, starting with index futures. It wanted exchange-traded contracts with a separate segment and clearing corporation, a minimum net worth for clearing members and certification for sales staff. It also supported treating derivatives as securities under the SCRA.

What is the J.R. Varma Committee known for?

It is known for risk containment. It recommended margins based on Value at Risk, with daily mark-to-market and a minimum margin on short option positions. This is the basis of the margining logic used by exchanges and clearing corporations.

What are the eligibility criteria for stocks in the F&O segment?

SEBI requires stocks to pass tests of size and liquidity, such as market capitalisation and traded value rank, order-size liquidity, market-wide position limit and delivery value. The numbers are revised from time to time. Check your workbook for the current limits.

Why must indices also meet eligibility criteria?

An index with too few constituents, or one dominated by a single stock, can be influenced more easily. SEBI therefore requires enough constituents, limits on concentration, and that constituents are liquid and mostly derivatives-eligible.