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

SCRA 1956 and Derivatives: Definition and Legal Status

Updated 11 October 2026 · Fact-checked

The Securities Contracts (Regulation) Act, 1956 (SCRA) is the law governing securities trading and stock exchanges. It includes derivatives within the definition of securities. Section 18A makes derivative contracts legal and valid only if traded on a recognised stock exchange and settled through its clearing house, as per the exchange's rules and byelaws. Check both conditions in every question.

Understand Securities Contracts (Regulation) Act, 1956 and Derivatives

The Securities Contracts (Regulation) Act, 1956 (SCRA) is the main Indian law that regulates dealings in securities and the working of stock exchanges. Its aim is to prevent undesirable transactions and to keep trading on organised, supervised platforms.

SCRA defines securities in Section 2(h). The list covers shares, scrips, stocks, bonds, debentures, government securities, units of mutual funds and collective investment schemes, and also a derivative. So a derivative is itself a security under Indian law. This matters because it brings derivatives under SCRA and the powers of SEBI.

Section 2(ac) defines derivative. In plain words it covers: a security derived from a debt instrument, share, loan, risk instrument or contract for differences; a contract that derives its value from the prices, or index of prices, of underlying securities; commodity derivatives; and any other instrument the Central Government declares to be a derivative. Equity futures and options on stocks and indices fit the second limb.

Section 18A is the key legal provision. It says that derivative contracts are legal and valid if they are traded on a recognised stock exchange and settled on the clearing house of that exchange, in accordance with its rules and byelaws. It applies despite anything in other laws. Before this, such contracts risked being treated as void wagering. Contracts outside these conditions, such as private OTC deals in equity derivatives, do not get this protection.

A stock exchange must be recognised under SCRA to host such trading. Recognition is granted on application, subject to conditions, and the exchange must follow its rules and byelaws, which are themselves subject to regulatory approval. SEBI exercises the regulatory powers for this in practice.

Key formulas to remember

Securities (Section 2(h))
Securities include shares, bonds, debentures, government securities, mutual fund units AND derivatives
A derivative is a security under SCRA, so SCRA and SEBI oversight apply to it.
Derivative (Section 2(ac))
Derivative = security derived from a debt instrument, share, loan, risk instrument or contract for differences | contract deriving value from prices or index of prices of underlying securities | commodity derivative | other instrument notified by the Central Government
Equity futures and options come under the 'value from prices or index of prices of underlying securities' limb.
Legality rule (Section 18A)
Legal and valid = traded on a recognised stock exchange AND settled on that exchange's clearing house, per its rules and byelaws
Both conditions must hold. Trading alone or settlement alone is not enough.

How to solve Securities Contracts (Regulation) Act, 1956 and Derivatives questions

Most SCRA questions test a definition or the legality condition. Use this method to avoid trap options.

  1. 1Identify what is asked: definition of securities, definition of derivative, legality of contracts, or exchange recognition.
  2. 2If it is about legality, recall Section 18A and test the option against both conditions: recognised stock exchange and clearing house settlement.
  3. 3If it is about definition, ask whether the option includes derivatives in securities (it does) and whether it covers value derived from prices or index of prices.
  4. 4Eliminate options that bring in a different body or law, such as AMFI approval or RBI registration, as the test of legality.
  5. 5Eliminate options with absolute words like 'only', 'never' or 'all' unless they match the rule exactly.
  6. 6Pick the option that matches the rule fully, not partly, then re-read the question for words like 'not' or 'except'.

Quickest way: Two-condition check for Section 18A

When to use it: Use for any question asking whether a derivative contract is legal or valid under SCRA.

  1. Ask: was it traded on a recognised stock exchange? If no, reject.
  2. Ask: was it settled on that exchange's clearing house under its rules and byelaws? If no, reject.
  3. If both are yes, the contract is legal and valid. Choose that option.

Common mistakes in Securities Contracts (Regulation) Act, 1956 and Derivatives

  • Thinking a derivative is not a security

    Students treat derivatives as just contracts on top of shares and bonds.

    Fix: Remember Section 2(h) lists derivative within securities. SCRA treats it as a security.

  • Applying only one condition of Section 18A

    Students remember 'traded on exchange' and forget the clearing house settlement part.

    Fix: Always state both: recognised exchange trading and settlement on its clearing house per rules and byelaws.

  • Attributing legality to SEBI or AMFI approval

    SEBI is prominent in the syllabus, so it feels like the source of legality.

    Fix: Legality of the contract comes from Section 18A of SCRA. AMFI deals with mutual funds, not derivatives legality.

  • Treating OTC equity derivatives as covered by Section 18A

    Students mix up general legality of contracts with the specific protection.

    Fix: The protection applies to contracts on a recognised exchange settled via its clearing house. OTC contracts outside this do not get it.

  • Mixing the SCRA definition with the SEBI Act or the Companies Act

    Several Acts appear in the same chapter and their names sound alike.

    Fix: Link each fact to its Act: SCRA for securities definition, derivative definition and exchange recognition; SEBI Act for the regulator's powers.

Worked examples

Example 1

Under the Securities Contracts (Regulation) Act, 1956, a derivative contract is legal and valid if it is: (A) traded on a recognised stock exchange and settled on the clearing house of that exchange as per its rules and byelaws; (B) any written agreement between two companies; (C) registered with the RBI only; (D) approved by AMFI.

Show the solution
  1. The question is about legality, so recall Section 18A.
  2. Section 18A requires trading on a recognised stock exchange and settlement on its clearing house per its rules and byelaws.
  3. Option B describes a private agreement, which does not satisfy either condition.
  4. Options C and D name bodies that are not the test of legality under this section.
  5. Only option A states both conditions.

Answer: Option A

Example 2

Which of the following is a derivative as per the SCRA definition? (A) A contract that derives its value from the index of prices of underlying securities; (B) A savings bank deposit; (C) The paid-up capital of a company; (D) A government subsidy.

Show the solution
  1. Recall that Section 2(ac) includes a contract which derives its value from the prices, or index of prices, of underlying securities.
  2. Option A matches this directly, for example an index futures or options contract.
  3. A savings deposit, paid-up capital and a subsidy do not derive value from prices of underlying securities.
  4. So B, C and D are not derivatives.

Answer: Option A

Exam tips

  • Learn the Section 18A wording as two linked conditions. Questions often drop one of them in a wrong option.
  • Remember only two section numbers firmly: 2(h) for securities, 2(ac) for derivative, plus 18A for legality. Do not guess others.
  • NISM-Series-VIII has negative marking of 25% of the marks of a question, so skip an option you cannot justify against the rule, rather than guess blindly.
  • Watch the words 'only', 'any' and 'not'. A trap option may be nearly right but add or remove a condition.
  • The pass mark for Series VIII is 60%, so these easy definition questions are marks you should secure.

Practice questions from Legal and Regulatory Environment

Securities Contracts (Regulation) Act, 1956 and Derivatives in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Securities Contracts (Regulation) Act, 1956 and Derivatives: frequently asked questions

What does SCRA 1956 say about derivatives?

SCRA includes derivatives in the definition of securities and defines a derivative in Section 2(ac). Section 18A makes derivative contracts legal and valid if traded on a recognised stock exchange and settled on its clearing house.

What is Section 18A of SCRA?

It is the provision that gives legal validity to derivative contracts. The contracts must be traded on a recognised stock exchange and settled on that exchange's clearing house, in accordance with its rules and byelaws.

Is a derivative a security under SCRA?

Yes. Section 2(h) lists a derivative among securities. This brings derivatives under the SCRA framework and SEBI's regulatory powers.

How does SCRA define a derivative?

A derivative covers a security derived from a debt instrument, share, loan, risk instrument or contract for differences, and a contract deriving value from prices or an index of prices of underlying securities. It also covers commodity derivatives and other instruments the Central Government declares.