FINANCE

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Islamic Derivatives – Stocks & the Islamic Capital Market 


A. Core Principle
  • All activities in the Islamic capital market must:
    • Fully comply with Shari’ah principles
  • Shari’ah acts as:
    • A complete guide for life
    • A legal framework for financial and commercial activities


B. Sources of Shari’ah Law
Shari’ah rules are derived from:
  • The Qur’an:
    • Holy book of Islam
    • Contains revealed word of God
    • Only a small portion (~3%) relates directly to legal rulings


  • The Sunnah of Prophet Muhammad (PBUH):
    • Sayings, actions, and approvals
    • Considered binding authority


  • Ijma (Consensus):
    • Agreement among qualified Muslim scholars
    • Helps address new financial issues


  • Qiyas (Analogy/Reasoning):
    • Applying existing rulings to new situations
    • Based on logical deduction


C. Role of Scholars & Industry Development
  • Collaboration between:
    • Shari’ah scholars
    • Business and financial experts
  • Purpose:
    • Develop practical and modern rulings
    • Adapt Shari’ah to new financial instruments


D. Impact of Ijma (Consensus Building)
  • Helps:
    • Reduce uncertainty and disagreement
    • Address criticisms and doubts
  • Even with differing opinions:
    • Some level of agreement (ijma) is achieved


E. Key Institutions Supporting Islamic Finance
  • Islamic Fiqh Academy
  • Accounting and Auditing Organization for Islamic Financial Institutions
  • Islamic Financial Services Board


F. Role of These Institutions
  • Provide:
    • Guidelines and standards
    • Shari’ah rulings (fatwas)
  • Aim to:
    • Unify and standardize practices
    • Strengthen global Islamic finance industry


G. Overall Impact
  • Development of:
    • More structured Islamic capital markets
  • Enhances:
    • Credibility and consistency
  • Supports:
    • Growth of Shari’ah-compliant financial systems


Final Takeaway
  • Islamic capital markets operate under:
    • Strict Shari’ah guidance
  • Built on:
    • Qur’an, Sunnah, Ijma, and Qiyas
  • Supported by:
    • Global institutions ensuring standardization and development

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Islamic Derivatives – Common Stock in Islamic Financial System 


A. Concept of Common Stock in Islam
  • Common stock is viewed as:
    • Similar to Mudarabah
  • Meaning:
    • Shareholders act like:
      • Providers of capital
    • Company acts as:
      • Entrepreneur/manager
  • Therefore:
    • Stock = profit and loss sharing certificate


B. Historical Origin
  • Conventional view:
    • Stocks originated in Western economies
  • Alternative view:
    • Dennis Holme Robertson (1933):
      • Traced origins to medieval Muslim traders


C. Nature of Ownership
  • Shareholders:
    • Are partial owners of the company
  • Rights include:
    • Share in profits (dividends)
    • Share in ownership benefits
    • Right to:
      • Vote in meetings
      • Elect directors


D. Risk and Responsibility
  • Shareholders must:
    • Bear residual risk (business losses)
  • In case of liquidation:
    • Third-party debts paid first
    • Remaining assets distributed to shareholders


E. Shari’ah Acceptance
  • Based on these features:
    • Scholars consider common stock:
      • Permissible (halal)
  • Approved by:
    • Islamic Fiqh Academy (1993)
  • Recognized as:
    • Valid investment instrument


F. Development of Islamic Capital Market Instruments
1. Modern Development (Post-2002)
  • Introduction of:
    • Shari’ah-compliant capital market instruments
  • Marked:
    • Rapid growth of Islamic finance


2. Contributing Factors
a. Growth of Islamic Finance
  • Especially since:
    • Mid-1990s onward
  • Increased demand for:
    • Shari’ah-compliant investments


b. Role of Key Institutions
  • Islamic Development Bank
  • Accounting and Auditing Organization for Islamic Financial Institutions
  • Islamic Financial Services Board
👉 Contributions:
  • Develop standards
  • Promote global Islamic finance


c. Evolution of Financial Transactions
  • Continuous innovation since:
    • Mid-1990s
  • Creation of:
    • New Shari’ah-compliant structures


G. Final Takeaway
  • Common stock:
    • Viewed as Mudarabah-based ownership
    • Involves:
      • Profit sharing
      • Risk sharing
  • Widely accepted as:
    • Permissible investment in Islam
  • Supported by:
    • Strong institutional development and modern financial evolution







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Islamic Derivatives – Capital Markets in Islamic Finance 


A. Types of Capital Markets
  • Modern financial system includes:
    • Stock market
    • Commodity / derivatives market


B. Role of Islamic Stock Market
  • Must operate in:
    • Full compliance with Shari’ah principles
  • Main function:
    • Transfer funds from:
      • Surplus units (investors)
      • To deficit units (businesses)


C. Key Objectives
  • Ensure:
    • Ethical and Shari’ah-compliant investment activities
  • Attract:
    • Surplus funds into productive investments


D. Investment Requirements (Shari’ah-Compliant)
  • Must consider:
    • Risk level
    • Expected return
    • Investment period
  • All must follow:
    • Islamic ethical rules (no riba, no exploitation, fairness)


E. Nature of Instruments in Stock Market
  • Includes:
    • Stock index futures
    • Stock options
    • Warrants


F. Complexity of These Instruments
  • These instruments are:
    • Complex and technical
  • Require:
    • Interpretation by scholars in:
      • Fiqh al-Muamalat


G. Scholarly Involvement
  • Opinions differ across:
    • Major schools of Islamic jurisprudence
  • Reason:
    • Need to assess:
      • Compliance with Shari’ah principles
      • Issues like:
        • Gharar
        • Maisir


H. Final Takeaway
  • Islamic capital markets aim to:
    • Combine financial efficiency with ethical compliance
  • However:
    • Modern instruments (futures, options, warrants) remain:
      • Debatable and subject to scholarly interpretation




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​Islamic Derivatives – Options


A. Definition of Options
  • Options are contracts giving the holder the right (not obligation) to:
    • Buy or sell a specific amount of a security
    • At a fixed price
    • Within a specified time period


B. Key Terms
  • Strike / Exercise Price:
    • Fixed price at which the asset can be bought or sold
  • Expiration Date:
    • Last date to exercise the option
    • Commonly falls on the third Friday of each month
  • Premium:
    • Amount paid to obtain the right to hold the option
  • Contract Size:
    • One option contract represents 100 shares of stock


C. Important Characteristics
  • The option holder:
    • Has a choice, not an obligation
  • Options are:
    • Not issued by the underlying company
    • Traded between investors in the market


D. Main Types of Option Strategies
1. Buying Call
  • Right to buy
  • Used when expecting price increase


2. Buying Put
  • Right to sell
  • Used when expecting price decrease


3. Selling Call
  • Obligation to sell if exercised
  • Used when expecting price to stay same or fall


4. Selling Put
  • Obligation to buy if exercised
  • Used when expecting price to stay same or rise


E. Key Insight
  • Options provide:
    • Flexibility and risk management
  • But also involve:
    • Gharar
    • Maisir


F. Final Takeaway
  • Options give the right to trade at a fixed price in the future
  • Require a premium payment
  • Widely used in markets but controversial in Islamic finance due to uncertainty and speculation

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​Islamic Derivatives – Option Pricing & Factors Affecting Premium


A. Option Premium (Price of Option)
  • Option premium = price paid to buy an option
  • Reflects:
    • Value of the right to buy or sell
  • Changes depending on:
    • Market conditions and key variables


B. Key Variables Affecting Option Price


1. Underlying Stock Price (S)
  • Call Option (Right to Buy):
    • If S increases → option price increases
    • Reason:
      • Buying at lower fixed price becomes more valuable
  • Put Option (Right to Sell):
    • If S increases → option price decreases
    • Reason:
      • Selling at fixed price becomes less attractive


2. Volatility (Price Fluctuation)
  • Call and Put Options:
    • If volatility increases → both option prices increase
  • Reason:
    • Greater price movement = higher chance of profit
    • Benefits both upward and downward positions


3. Time to Maturity
  • Call and Put Options:
    • More time → higher option price
  • Reason:
    • More time increases probability of favorable price movement


4. Strike Price (K)
  • Call Option:
    • If K increases → option price decreases
    • Reason:
      • Buying at a higher price is less attractive
  • Put Option:
    • If K increases → option price increases
    • Reason:
      • Selling at a higher price is more valuable


5. Interest Rates
  • Call Option:
    • If interest rates increase → option price increases
  • Put Option:
    • If interest rates increase → option price decreases
  • Reason:
    • Higher rates reduce present value of future payments
    • Makes call options relatively more attractive


C. Overall Pricing Logic
  • Option price (premium) depends on:
    • Relationship between S (market price) and K (strike price)
    • Time available
    • Market uncertainty (volatility)
    • Economic conditions (interest rates)


D. Simple Summary
Call Option Price Increases When:
  • Stock price (S) ↑
  • Volatility ↑
  • Time ↑
  • Interest rates ↑
  • Strike price (K) ↓


Put Option Price Increases When:
  • Stock price (S) ↓
  • Volatility ↑
  • Time ↑
  • Interest rates ↓
  • Strike price (K) ↑


E. Key Insight
  • Option pricing is based on:
    • Probability of profit
  • Any factor that:
    • Increases chance of gain → raises option price
    • Reduces chance → lowers option price


F. Shari’ah Reflection
  • Despite pricing logic, options raise concerns:
    • Gharar
    • Maisir


Final Takeaway
  • Option premium is not fixed
  • It changes based on:
    • Market price, time, volatility, strike price, and interest rates
  • Understanding these factors is key to:
    • Valuing and using options effectively

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Islamic Derivatives – Making Money with Stock Options (Rewritten with Call & Put)


A. Key Terms
  • S (Stock Price) = Current market price of the share
  • K (Strike Price) = Fixed price in the option contract
  • Spread = Difference between market price and strike price


B. Spread (Profit Concept)
  • For Call Option:
    • Spread = S − K
  • For Put Option:
    • Spread = K − S


C. Example
  • K = $10
  • S = $25
  • Call option:
    • Spread = 25 − 10 = $15 profit
  • Put option:
    • Spread = 10 − 25 = −$15 (no profit, not exercised)


D. Option Status (Moneyness)


1. Call Option (Right to Buy)
  • In-the-Money (ITM):
    • S > K
    • ✔️ Profit (buy cheap, sell high)
  • At-the-Money (ATM):
    • S = K
    • No profit, no loss
  • Out-of-the-Money (OTM):
    • S < K
    • ❌ Not worth exercising


2. Put Option (Right to Sell)
  • In-the-Money (ITM):
    • S < K
    • ✔️ Profit (sell high, market low)
  • At-the-Money (ATM):
    • S = K
    • No profit, no loss
  • Out-of-the-Money (OTM):
    • S > K
    • ❌ Not worth exercising


E. Profit Logic Summary
  • Call option:
    • Profit when price rises (S > K)
  • Put option:
    • Profit when price falls (S < K)


F. Public vs Private Company Options
Public Company
  • Shares:
    • Easily traded in market
  • Employee can:
    • Exercise option → sell immediately → profit


Private Company
  • Shares:
    • Not easily tradable
  • Profit depends on:
    • Company buyback, or
    • Events like:
      • IPO
      • Company sale


G. Key Insight
  • Profit depends on:
    • Relationship between S and K
  • But actual cash profit depends on:
    • Ability to sell shares


H. Shari’ah Reflection
  • Options involve concerns such as:
    • Gharar
    • Maisir


Final Takeaway
  • ✔️ Call = profit when S > K
  • ✔️ Put = profit when S < K
  • ✔️ Spread determines profit
  • ❗ Liquidity determines whether profit can actually be realized


If you want, I can compress this into a super short exam answer (5 lines) 👍

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Islamic Derivatives - Stock Options vs Warrants 
✔️ Yes — stock options and warrants are similar
❗ But they are not the same (important differences)


Islamic Derivatives – Stock Options vs Warrants (Notes)


A. Similarities
  • Both give:
    • Right (not obligation) to buy shares
  • Both have:
    • Exercise (strike) price
    • Expiry date
  • Profit when:
    • Market price exceeds exercise price
  • Used for:
    • Investment or incentives (employees)


B. Key Differences
1. Who Issues Them
  • Stock option:
    • Issued by:
      • Company (employee stock options), or
      • Market participants (traded options)
  • Warrant:
    • Always issued by:
      • The company itself


2. Source of Shares
  • Stock option:
    • Shares may come from:
      • Existing shares (market or treasury)
  • Warrant:
    • Shares are:
      • Newly issued by company


3. Effect on Company
  • Stock option:
    • Usually:
      • No major change in total shares (if from market)
  • Warrant:
    • ✔️ Increases:
      • Number of shares outstanding


4. Purpose
  • Stock option:
    • Often used as:
      • Employee compensation/incentive
  • Warrant:
    • Often used to:
      • Attract investors
      • Enhance bonds or financing deals


5. Tradability
  • Stock options (market):
    • Frequently traded actively
  • Warrants:
    • Sometimes tradable, but:
      • Often tied to company-issued instruments


C. Shari’ah Insight
  • Both raise concerns due to:
    • Gharar
    • Maisir
  • Warrants may be viewed slightly more favorably because:
    • Linked to real share issuance and ownership


Final Takeaway
  • ✔️ Both = right to buy shares at fixed price
  • ❗ Main difference:
    • Stock option = broader concept (employee/market-based)
    • Warrant = company-issued right creating new

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​Islamic Derivatives – Stock Options


A. Definition
  • Stock options = contracts giving the holder:
    • Right (not obligation) to buy a fixed number of company shares
    • At a fixed price (exercise/strike price)
    • Within a specified time period


B. Key Features
  • Granted by:
    • Employer (company) with approval of board of directors
  • Specifies:
    • Number of shares
    • Exercise price
    • Time period (expiry)
  • May include:
    • A future start date (when option becomes active)


C. Exercise Price (Strike Price)
  • Price paid to buy the shares
  • Usually equal to:
    • Market price at grant date


D. How Profit is Made
  • If stock price increases above exercise price:
    • Employee buys shares at lower fixed price
    • Can sell at higher market price → profit
  • If stock price does not increase:
    • Option may be left unexercised
    • No obligation to buy


E. Rights of Option Holder
  • Before exercise:
    • ❌ No:
      • Voting rights
      • Dividend rights
  • After exercise:
    • ✔️ Becomes shareholder
    • Gains:
      • Ownership rights
      • Voting and dividends


F. Exercise of Option
  • Happens when:
    • Holder pays exercise price
  • Result:
    • Shares registered in holder’s name
    • Status changes to shareholder


G. Vesting Requirement
  • Options cannot be exercised immediately
  • Must first vest (conditions fulfilled)


Types of Vesting
1. Time-Based Vesting
  • Based on:
    • Continued employment over time


2. Performance-Based Vesting
  • Based on:
    • Achieving individual or company targets


H. Exercise Period
  • Time allowed to exercise option after vesting
  • Common duration:
    • Up to 10 years
  • If not exercised:
    • Option expires


I. Effect of Employment Termination
  • Usually:
    • Exercise period is shortened
  • Some plans:
    • Options expire immediately
  • Others allow:
    • Short continuation (e.g. 90 days)
  • Exceptions:
    • Death, disability, retirement


J. Methods of Paying Exercise Price
  • Payment can be:
    • Cash (cheque)
    • Loan from company
    • Using existing shares


K. Key Takeaway
  • Stock options:
    • Incentivize employees
    • Allow participation in company growth
  • Provide:
    • Potential profit with limited obligation
  • But still raise Shari’ah concerns due to:
    • Gharar
    • Maisir

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​HIslamic Derivatives – Shari’ah View on Conventional Options (Notes Form)


A. General Position
  • Conventional options are generally not approved under Shari’ah
  • Majority of Muslim jurists:
    • Consider them impermissible


B. Ruling by Islamic Authority
  • Islamic Fiqh Academy (OIC):
    • Declared options not permissible
  • Reason:
    • Subject matter of options is:
      • Not money
      • Not a tangible asset
      • Not a valid transferable right under Shari’ah


C. Reasons for Prohibition (Majority View)
1. Involvement of Gambling
  • Options resemble:
    • Maisir
  • Outcome depends heavily on:
    • price movements and chance


2. Excessive Speculation
  • High level of:
    • Market guessing and uncertainty
  • Leads to:
    • Gharar


3. Issue of Premium
  • Premium paid for the option:
    • Seen as unjustified
    • No clear countervalue (asset/service)
  • Therefore:
    • Considered invalid in Shari’ah


D. Minority View (Alternative Opinion)
  • Some scholars believe:
    • Options can be permissible with modifications
  • Argument:
    • Options can serve:
      • Risk management (hedging)
      • Legitimate business needs


E. Development of Shari’ah-Compliant Alternatives
  • Islamic financial institutions (IFIs):
    • Attempt to design Shari’ah-compliant options
  • Based on minority opinion:
    • Adjust structure to:
      • Avoid riba, gharar, and maisir
      • Link to real assets and contracts


F. Final Takeaway
  • Majority view:
    • Conventional options = not permissible
  • Minority view:
    • Allows modified, Shari’ah-compliant versions
  • Result:
    • Ongoing effort to create Islamic alternatives to options










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Islamic  Derivatives – Why Warrants Are Linked to Real Assets but Options Are Not 


A. Warrants → Direct Link to Real Asset
  • Warrant gives:
    • Right to buy actual company shares
  • When exercised:
    • ✔️ You receive real shares
    • ✔️ Company issues new shares
  • So:
    • There is a clear underlying asset (equity/shares)
    • Leads to real ownership
👉 Key idea:
  • Warrant → ends in actual asset transfer


B. Options → Often Not Linked in Practice
  • Option gives:
    • Right to buy or sell
  • BUT in reality:
    • Most options are:
      • Traded repeatedly
      • Closed before expiry
      • Settled in cash (no delivery)
👉 So:
  • ❌ No actual asset exchanged
  • ❌ No real ownership happens


C. Nature of Trading
Warrants
  • Usually:
    • Held until exercised
  • Purpose:
    • Investment in company shares


Options
  • Commonly used for:
    • Speculation
    • Price betting
  • Traders:
    • Rarely intend to own the asset


D. Shari’ah Concern
  • Options involve:
    • Gharar
    • Maisir
  • Because:
    • Focus is on price movement, not ownership


E. Key Conceptual Difference
  • Warrant:
    • Right tied to real shares issued by company
    • Leads to actual ownership
  • Option:
    • Right often treated as a tradable financial claim
    • May never lead to real asset transfer


F. Important Clarification
  • It’s not that options cannot involve real assets
  • The issue is:
    • How they are used in practice
    • Heavy speculation + no delivery


Final Takeaway
  • ✔️ Warrants = closer to real asset-based transaction
  • ❗ Options = often detached from real assets in practice
  • 👉 That’s why warrants are sometimes viewed as more acceptable (relatively) in Islamic finance


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