FINANCE

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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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