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NISM-Series-VIII: Equity Derivatives · Sales Practices and Investors Protection Services

Sales Practices and Code of Conduct for Derivatives

Updated 11 October 2026 · Fact-checked

Sales practices and code of conduct set the ethical rules for selling equity derivatives. You must know the client through KYC, check suitability, give fair and complete risk disclosure, never guarantee returns, never trade without client authority, and put the client's interest first. In MCQs, pick the option that protects the client.

Understand Sales Practices and Code of Conduct for Derivatives

Derivatives are leveraged and can cause losses larger than the money a client first puts in. So the rules for selling them are strict. The aim is simple: the client should understand what they are buying, be able to bear the risk, and not be misled.

Know Your Client (KYC) comes first. A broker or intermediary must identify the client, collect proper documents and understand the client's financial position, trading experience and objectives. Without this, you cannot judge what is suitable.

Suitability means the product or strategy must match the client's profile. A retired person with low income and low risk appetite is not a fit for aggressive short option positions. A good intermediary recommends only what suits the client, even if a riskier product earns higher commission.

Mis-selling means selling a product by hiding risks, exaggerating gains, promising or implying assured returns, or pushing an unsuitable product. Unauthorised trading means dealing in a client's account without the client's instruction or valid authority. Both breach the code of conduct and can lead to client complaints, arbitration and SEBI or exchange action.

The code of conduct also covers fair dealing: honesty, integrity, diligence, no front-running, no misuse of client funds or securities, no conflict of interest left undisclosed, and keeping proper records. Execution-only service means the client decides and the broker only executes. Advice means the intermediary recommends, so suitability duties apply fully. Treat any recommendation as advice. Exact registration rules for advice should be taken from the NISM workbook and SEBI regulations.

Key formulas to remember

Core sequence
KYC → Risk profiling → Suitability → Risk disclosure → Client's own order → Records
Use this order to test any scenario. The step that is missing is usually the breach.
Mis-selling test
Hidden risk OR assured return OR unsuitable product = mis-selling
Any one of these is enough.
Unauthorised trading test
No client instruction or valid authority = unauthorised trade
Verbal or past comfort does not replace proper authority. Follow the intermediary's documented order process.
Advice vs execution-only
Recommendation given = advice (suitability applies); client decides alone = execution-only
Execution-only does not allow misleading statements or ignoring client rules.

How to solve Sales Practices and Code of Conduct for Derivatives questions

Use this method for any scenario or code-of-conduct MCQ.

  1. 1Read the scenario and identify who the client is and what they want.
  2. 2Check KYC: was the client identified and the profile collected?
  3. 3Check suitability: does the product or strategy match the client's risk capacity and experience?
  4. 4Check disclosure: were risks, including possible losses beyond the initial margin, explained fairly? Were returns promised?
  5. 5Check authority: did the client give the order, or did the broker trade on its own?
  6. 6Check conflicts: did the intermediary put its own commission or interest above the client's?
  7. 7Choose the option that protects the client and follows the code. Reject absolute words like 'always guaranteed'.

Quickest way: Client-first elimination

When to use it: When time is short and options look similar.

  1. Strike out any option that promises or guarantees returns.
  2. Strike out any option where the broker trades without client instruction.
  3. Strike out any option that skips KYC or risk disclosure.
  4. Of the remaining options, choose the one that is honest, suitable and documented.

Common mistakes in Sales Practices and Code of Conduct for Derivatives

  • Thinking a client's willingness to take risk makes any product suitable.

    Students treat consent as the only test.

    Fix: Suitability also needs financial capacity and experience. Check all three, not just willingness.

  • Treating a broker's call to 'buy this option' as execution-only.

    The broker still executes the trade, so it seems like plain broking.

    Fix: If the broker recommends, it is advice, and suitability duties apply.

  • Accepting 'trade on my behalf, I trust you' as full authority.

    Trust feels like permission.

    Fix: Trading needs proper client instruction or valid, documented authority. Informal trust does not cure unauthorised trading.

  • Calling any loss-making recommendation mis-selling.

    Students link mis-selling to outcome.

    Fix: Mis-selling is about how it was sold: hidden risk, assured returns, or unsuitability. A fair, suitable sale that loses is not mis-selling.

  • Forgetting that KYC is a continuing duty.

    KYC is seen as a one-time form.

    Fix: Profiles change, so intermediaries should keep client information updated.

Worked examples

Example 1

A broker tells a new client with no market experience, 'Sell these index options. The premium income is almost assured, and you will never lose.' Which code-of-conduct principles are breached?
A) None, as the client agreed
B) Only KYC
C) Suitability and fair risk disclosure, with an assured-return claim
D) Only record keeping

Show the solution
  1. Client has no experience, and short options can have very large losses.
  2. Selling such positions to this client is unsuitable.
  3. 'Almost assured' and 'never lose' hide risk and imply a guaranteed outcome.
  4. So suitability and fair disclosure are breached. Client agreement does not cure mis-selling.

Answer: C

Example 2

A client placed a Nifty futures order by phone. Later the broker, thinking the market would rise, buys more lots in the client's account without asking. Is this allowed?

Show the solution
  1. Identify the extra lots: no client instruction was given for them.
  2. Check authority: no valid authority covers those trades.
  3. Such dealing is unauthorised trading and breaches the code of conduct.
  4. The broker's good intention or expected profit does not change this.

Answer: Not allowed. The additional trades are unauthorised trading, and the client can complain to the broker, the exchange or SEBI.

Exam tips

  • Scenario MCQs usually hide one breach. Look for guaranteed returns, missing KYC, or trades without client instruction.
  • Options with words like 'always' or 'assured' on returns are almost always wrong.
  • When choosing between two good-looking options, pick the one that protects the client.
  • Do not guess on 2-mark questions without eliminating options, as wrong answers carry 25% negative marking of the question's marks.
  • Learn the difference between advice and execution-only, and between mis-selling and plain loss.

Practice questions from Sales Practices and Investors Protection Services

Sales Practices and Code of Conduct for Derivatives: frequently asked questions

What is mis-selling in derivatives?

It is selling a derivative product by hiding or understating risk, promising assured returns, or pushing a product that does not suit the client. It is judged by how the sale was made, not by whether the client lost money.

Why are suitability and KYC important for derivatives clients?

Derivatives are leveraged, so losses can be large. KYC gives the facts about the client, and suitability uses those facts to decide whether a product or strategy fits the client's risk capacity and experience.

What is the difference between advice and execution-only in derivatives broking?

In execution-only, the client decides and the broker only places the order. In advice, the intermediary recommends a trade or strategy, so it must ensure the recommendation is suitable and the risks are disclosed.

What is unauthorised trading?

It means entering trades in a client's account without the client's instruction or valid authority. It breaches the code of conduct, and the client can seek redress through grievance and arbitration routes.