FINANCE

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​Islamic Derivatives – What is Short Selling?
  • Definition:
    • Short selling = selling an asset you do not own with the intention of buying it later at a lower price


  • How it works (simple steps):
    1. A trader sells a commodity/asset at the current market price
    2. The trader does not actually own the asset at that time
    3. Later, the trader buys it back at a lower price
    4. Profit = difference between selling price and buying price


  • Example:
    • Sell a stock at $100 (without owning it)
    • Later buy it at $80
    • Profit = $20


  • Why people do it:
    • To profit from falling prices
    • Common in financial markets like stocks and futures


Shari’ah Perspective
  • Main issue:
    • Selling something not owned or possessed
  • Violates key Islamic principle:
    • “Do not sell what you do not own”


  • Related concerns:
    • Involves uncertainty (Gharar)
    • May include speculation similar to Maisir
    • Ownership transfer is not valid at time of sale


Key takeaway:
  • Short selling = selling first, owning later
  • Generally considered not permissible in Islamic finance because:
    • No ownership
    • High uncertainty
    • Speculative nature

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​Islamic Derivatives – Options Contracts 


Basic Concept of Options
  • An option contract gives the buyer:
    • Right (not obligation) to buy or sell an asset
    • At a fixed price
    • On or before a future date
  • Buyer must pay a premium:
    • Fee paid to seller for this right
    • Loss is limited to this premium amount


Types of Options
1. Call Option (Right to Buy)
  • Gives buyer the right to purchase an asset
  • Price is fixed in advance
  • Used when expecting price increase
Outcome:
  • If price rises → buyer profits
  • If price falls → buyer lets option expire (loss = premium only)


2. Put Option (Right to Sell)
  • Gives buyer the right to sell an asset
  • Price is fixed in advance
  • Used when expecting price decrease
Outcome:
  • If price falls → buyer sells at higher fixed price → profit
  • If price rises → buyer lets option expire (loss = premium only)


Example – Call Option (A)
  • A expects stock price to increase
  • Choices:
    • Buy stock fully, or
    • Pay premium for call option
  • If price rises:
    • A benefits
  • If price falls:
    • A does not exercise option
    • Loss = premium only


Example – Put Option (B)
  • B expects stock price to decrease
  • Choices:
    • Sell stock now, or
    • Buy put option
  • If price falls:
    • B sells at fixed higher price → profit
  • If price rises:
    • B lets option expire
    • Loss = premium only


Key Takeaways
  • Options = right without obligation
  • Premium = cost of flexibility
  • Helps manage risk and speculation
  • Widely used in financial markets, but raises Shari’ah concerns (ownership, uncertainty, speculation)




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​Islamic Derivatives – Combined Options


Use of Combined Options
  • Businesses use:
    • Call + Put options together
  • Purpose:
    • Hedge risk from:
      • Currency fluctuations (e.g. USD)
      • Commodity price changes


What is a Combined Option?
  • Combination of:
    • Call option → right to buy
    • Put option → right to sell
  • Designed so that:
    • One option offsets the loss of the other


Corrected Example (C and USD Fluctuation)
  • C is worried that USD value may change and affect a contract
  • To reduce risk, C buys a combined option (call + put)


Outcomes
1. If USD value increases
  • ✅ Call option is exercised
    • C can buy at lower fixed price
    • → Gains profit / saves cost
  • ❌ Put option is not used
  • ✔️ Profit from call helps offset premium cost


2. If USD value decreases
  • ✅ Put option is exercised
    • C can sell at higher fixed price
    • → Gains profit
  • ❌ Call option is not used
  • ✔️ Profit from put helps offset premium cost


Key Idea
  • Combined options provide:
    • Protection in both directions (price up or down)
    • A form of risk management (hedging)


Important Insight
  • Only one option is useful at a time:
    • Call → when prices rise
    • Put → when prices fall


Shari’ah Note
  • Despite hedging benefits, concerns remain:
    • Gharar
    • Maisir
  • Therefore, permissibility is debated among scholars


Final Takeaway
  • ✔️ The corrected logic:
    • Call = benefit when price rises
    • Put = benefit when price falls
  • ✔️ Combined options = balanced risk protection, not contradiction




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​Islamic Derivatives – Stand-alone vs Embedded Options 
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A. Basic Concept of Options
  • Option = right (not obligation) to:
    • Buy or sell an asset
    • At a fixed price
    • On or before a future date
  • Buyer pays a premium for this right


B. Types of Options
  • Call option:
    • Right to buy
    • Used when expecting price increase
  • Put option:
    • Right to sell
    • Used when expecting price decrease


C. Stand-alone Options
Definition
  • Options that are:
    • Separate and independent contracts
    • Bought and sold individually in markets


Key Features
  • Require separate premium payment
  • Can be traded freely (stocks, currencies, commodities)
  • Often used for:
    • Speculation
    • Risk hedging


Examples
  • Buying a call option on shares:
    • Pay premium → right to buy shares later
  • Buying a put option on USD:
    • Pay premium → right to sell currency at fixed rate


Scenario
  • Pay RM500 for option to buy gold at RM10,000
  • If price rises → exercise → profit
  • If price falls → do nothing → lose premium only


Nature
  • Pure financial instrument
  • Not tied to a real transaction
  • Exists on its own


D. Embedded Options
Definition
  • Options that are:
    • Built into another contract
    • Not sold separately


Key Features
  • No separate premium:
    • Cost included in overall contract price
  • Not traded independently
  • Provide flexibility in real business transactions


Examples
  • Cancellation option:
    • Buyer/seller can cancel contract before execution
  • Lease (Ijarah) with purchase option:
    • Customer may choose to buy asset at end
  • Early settlement option:
    • Buyer can repay financing earlier
  • Callable sukuk:
    • Issuer can redeem earlier than maturity


Scenario
  • Contract to buy goods at RM10,000
  • Clause allows cancellation before delivery
  • If price drops → cancel contract
  • If price rises → continue contract


Nature
  • Part of a real economic transaction
  • Provides practical flexibility, not speculation


E. Key Differences (in points)
  • Stand-alone options are separate contracts; embedded options are part of another contract
  • Stand-alone options require separate premium; embedded options have cost included in price
  • Stand-alone options are actively traded; embedded options are not tradable separately
  • Stand-alone options are often used for speculation; embedded options are for contract flexibility


F. Similarity
  • Both provide:
    • Right without obligation


G. Shari’ah Perspective
  • Stand-alone options:
    • Involve:
      • Gharar
      • Maisir
    • Generally questionable or not permissible
  • Embedded options:
    • More acceptable when:
      • Linked to real contracts and assets
      • Not purely speculative


H. Final Takeaway
  • Stand-alone options = independent, tradable, speculative
  • Embedded options = built-in rights within real contracts
  • Main difference = purpose and structure, not just the “right” itself




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Islamic Derivatives – Minority View & Warrants 


A. Minority View on Options
  • Some scholars (minority opinion):
    • Believe options can be approved
  • Reason:
    • Useful for:
      • Risk management (hedging)
      • Business needs


B. Role of Shari’ah Boards
  • Shari’ah boards in Islamic Financial Institutions (IFIs):
    • Adopt minority opinions
  • Aim:
    • Develop Shari’ah-compliant alternatives to conventional options
  • Approach:
    • Modify structure to:
      • Avoid Maisir
      • Avoid Gharar
      • Link to real assets and transactions


C. Warrants (Basic Concept)
Definition
  • Warrant = corporate security similar to a call option
  • Gives holder:
    • Right (not obligation) to buy company shares
    • At a fixed price
    • Within a specific time period


Key Features of Warrants
  • Specify:
    • Number of shares
    • Exercise price
    • Expiry date
  • Often:
    • Attached to bonds when issued
  • Buyer:
    • Can choose whether to exercise or not


Investor Perspective
  • Warrants are similar to:
    • Call options on shares
  • Benefit:
    • Buy shares at fixed (possibly lower) price


D. Difference Between Warrants and Call Options
1. Issuance
  • Call option:
    • Issued by individual investors/traders
  • Warrant:
    • Issued by the company itself


2. When Exercised
  • Call option:
    • Buyer purchases shares from another investor
    • Company is not directly involved
  • Warrant:
    • Buyer purchases shares directly from company
    • Company:
      • Receives money
      • Issues new shares


3. Effect on Company
  • Call option:
    • No change in company shares
  • Warrant:
    • Increases number of shares outstanding


E. Shari’ah Insight
  • Warrants may be viewed more favorably than options if:
    • Linked to real shares (underlying asset)
    • Not purely speculative
  • Still debated depending on:
    • Structure and usage


F. Final Takeaway
  • Minority scholars support developing Islamic alternatives
  • Warrants:
    • Function like call options
    • But differ in:
      • Issuer (company vs investor)
      • Impact on shares
  • Seen as a possible bridge toward Shari’ah-compliant option-like instruments

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Islamic Derivatives – How Warrants Work 


A. Basic Idea of a Warrant
  • Warrant = right (not obligation) to buy shares
  • Very similar to a call option only
  • Issued by the company, not traders


B. Does a Warrant Have Call or Put?
  • ✔️ Warrant = like a CALL option
    • Right to buy shares at fixed price
  • ❌ No “put warrant” in the usual sense
    • It does not give right to sell


C. Is There a Premium?
  • ✔️ Yes, but different from options:
    • You pay to get the warrant
    • Cost may be:
      • Paid directly, or
      • Included in another product (e.g. bond)
👉 So:
  • It behaves like a premium, but:
    • Not always shown separately
    • Sometimes embedded in price


D. How It Works (Step-by-Step)
  1. You receive or buy a warrant
    • Example: Right to buy shares at RM10
  2. Wait until future date
  3. Two outcomes:
  • If market price = RM15:
    • ✔️ Exercise warrant
    • Buy at RM10 → profit
  • If market price = RM8:
    • ❌ Do not exercise
    • Let it expire → loss limited to cost of warrant


E. Key Difference from Call Option
  • Call option:
    • Buy shares from another investor
  • Warrant:
    • Buy shares directly from the company
    • Company issues new shares


F. Simple Comparison
  • Warrant:
    • ✔️ Right to buy
    • ✔️ Issued by company
    • ✔️ May have implicit premium
    • ❌ No selling right


G. Shari’ah Insight
  • More acceptable (in some views) because:
    • Linked to real shares
  • But still debated due to:
    • Gharar
    • Maisir


H. Final Takeaway
  • Warrant = company-issued call option (only buy right)
  • Has cost like premium, but may be embedded
  • Used to buy shares in future at fixed price

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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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Islamic Derivatives – Minority View, Warrants & Shari’ah Issues

A. Minority View on Options
  • Some scholars (minority opinion):
    • Support approval of options
  • Reason:
    • Useful for:
      • Risk management (hedging)
      • Protecting against market uncertainty
  • Islamic Financial Institutions (IFIs):
    • Through Shari’ah boards, adopt this view
    • Develop Shari’ah-compliant alternatives to conventional options


B. Warrants (Concept & Features)
Definition
  • Warrant = corporate security similar to a call option
  • Gives holder:
    • Right (not obligation) to buy shares
    • At a fixed price
    • Within a specific time period


Key Features
  • Specifies:
    • Number of shares
    • Exercise price
    • Expiry date
  • Often:
    • Attached to bonds when issued
  • Buyer:
    • Has choice to exercise or not


Investor Perspective
  • Similar to:
    • Call option on shares
  • Benefit:
    • Buy shares at pre-agreed price


Company Perspective
  • Key difference from call options:
    • Warrant issued by company
    • Call option issued by investors/traders


When Exercised
  • Call option:
    • Shares bought from other investors
    • Company not involved
  • Warrant:
    • Shares bought directly from company
    • Company:
      • Receives money
      • Issues new shares (increase in shares outstanding)


C. Shari’ah Concern on Warrants (Embedded Options)
Main Issue: Uncertainty (Gharar)
  • Concern:
    • Gharar
  • Reason:
    • Future price of shares is unknown
    • Decision to:
      • Exercise or cancel is uncertain


Speculation Issue
  • Some investors may:
    • Use warrants for speculation only
  • Leads to:
    • Maisir


Scholarly View (Jobst, 2007)
  • Options may involve:
    • Gharar fahish (excessive uncertainty)
  • Due to:
    • Lack of clarity about future outcomes


D. Legal Maxim (Qawa’id Fiqhiyyah)
  • Dar’ al-mafasid muqaddam min jalb al-masalih
  • Meaning:
    • Avoiding harm is prioritized over gaining benefit
  • Used to argue:
    • Options may be prohibited due to risk and speculation


E. Alternative View (Permissibility with Conditions)
  • Some jurists allow embedded options (like warrants) because:
    • Obligations are:
      • Between two parties only
      • Not transferable to third parties
  • This reduces:
    • Speculative trading


Important Consequence
  • Restricting transferability:
    • May limit or eliminate organized options markets


F. Role of Options in Modern Economy
  • Seen as:
    • Hedging instruments (risk reduction tools)
  • Important for:
    • Managing economic fluctuations
  • Serve:
    • Public interest (maslahah)
    • Welfare of the ummah (community)


G. Balanced View
  • Issues like:
    • Gharar
    • Maisir
    • Often arise due to:
      • Speculative misuse by some investors
  • Argument:
    • Cannot generalize prohibition for all options


H. Final Insight
  • No exact equivalent in classical Fiqh al-Muamalat
    for modern derivatives like:
    • Futures
    • Options
    • Warrants


Conclusion
  • Must evaluate:
    • Both benefits and risks
  • Use:
    • Islamic principles to assess permissibility
  • Outcome:
    • Ongoing debate between:
      • Prohibition (majority)
      • Conditional permissibility (minority)

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Short Answer
✔️ Yes — a warrant is generally considered a type of embedded option
…but with a small nuance.


Islamic Derivatives – Warrant as Embedded Option (Notes)


A. Why Warrant is Considered an Embedded Option
  • A warrant gives:
    • Right (not obligation) to buy shares
  • This “right” is:
    • Built into another financial instrument (often bonds or company issuance)
  • Therefore:
    • It behaves like an option inside a larger product
👉 Hence:
  • Warrant = embedded call option–like feature


B. Why It Is NOT Exactly Like Typical Embedded Options
  • Typical embedded option:
    • Hidden inside contracts like:
      • Lease (Ijarah)
      • Financing agreements
  • Warrant:
    • Sometimes can be:
      • Detached and traded separately
👉 So:
  • It is:
    • ✔️ Embedded at issuance
    • ❗ But can behave like a stand-alone instrument later


C. Key Characteristics of Warrants
  • ✔️ Right to buy shares only (like call option)
  • ✔️ Issued by company
  • ✔️ May be:
    • Attached to bonds (embedded), or
    • Traded separately (quasi stand-alone)


D. Shari’ah Perspective Insight
  • Considered closer to embedded options because:
    • Linked to real shares
  • But concerns remain:
    • Gharar
    • Maisir
  • Especially when:
    • Actively traded for speculation


Final Takeaway
  • ✔️ Warrant = embedded option at origin
  • ❗ Can become stand-alone-like when traded separately
  • 👉 Best description:
    • “Hybrid between embedded and stand-

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KembaraXtra – Islamic Derivatives: Employee Stock Options (ESO) – Simplified Notes


🔹 1. What is a Stock Option (Employee Option)?
 
👉 A stock option gives an employee:
  • The right (not obligation)
  • To buy company shares
  • At a fixed price (exercise/strike price)
  • Within a specific time period


🔹 2. Key Features
 
✔ Exercise Price (Strike Price)
  • Fixed price to buy shares
  • Usually equal to market price at grant date


✔ Expiry Period
  • Time limit to exercise option
  • Common: up to 10 years


✔ No Shareholder Rights Initially
 
👉 Before exercise:
  • ❌ No voting rights
  • ❌ No dividends
 
👉 After exercise:
  • ✔ Becomes shareholder


🔹 3. How Profit is Made
 
📅 Scenario
  • Exercise price = RM10
  • Market price = RM15
 
👉 Employee buys at RM10
👉 Can sell at RM15
 
✔ Profit = RM5 per share


🔹 4. When Option is Exercised
 
👉 Exercise happens when:
  • Employee pays the exercise price
  • Shares are transferred to employee
 
✔ Now becomes shareholder


🔹 5. Vesting (Very Important)
 
👉 Option cannot be used immediately
 
✔ Must wait until vesting conditions are met


🔸 Types of Vesting
 
✔ Time-Based Vesting
  • Must work for company for certain years


✔ Performance-Based Vesting
  • Must achieve:
    • Individual targets
    • Company goals


🔹 6. Expiry Rules
 
👉 If not exercised within time:
  • ❌ Option expires
  • ❌ No value


🔹 7. If Employee Leaves Company
 
👉 Usually:
  • Exercise period is shortened
 
Examples:
  • Must exercise within 90 days
  • Or option may expire immediately


🔹 8. Payment Methods
 
👉 Employee can pay exercise price by:
  • ✔ Cash
  • ✔ Loan from company
  • ✔ Existing shares


🔹 9. Key Insight
 
👉 Employee stock options are used to:
  • Motivate employees
  • Align employee interest with company performance


🔹 Simple Summary
  • Stock option = right to buy shares later
  • Must wait for vesting
  • Profit when market price > strike price
  • No rights until exercised


🔹 Final Exam Insight
 
👉 “Employee stock options grant the right to purchase company shares at a predetermined price after meeting vesting conditions, allowing employees to benefit from future increases in share value.”
 

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