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KembaraXtra-Islamic Finance-Islamic Capital Market-Put Options and Call Options: Meaning, Mechanism, and Enforceability
What Is an Option (General Idea)
An option is a financial contract that gives the holder a right, but not an obligation, to buy or sell an underlying asset at a predetermined price (called the strike price) within a specified period. The seller (writer) of the option has the obligation to fulfil the contract if the holder chooses to exercise the option.
Call Option
Meaning
A call option gives the holder the right to buy an asset at a fixed price on or before a certain date.
When Investors Use It
Call options are used when an investor expects the price of an asset to increase.
Simple Example
If the share price rises to USD 70, the investor exercises the call option and buys at USD 55.
Profit = (70 − 55) − 3 = USD 12
If the price stays below USD 55, the investor does not exercise the option and loses only the premium of USD 3.
Put Option
Meaning
A put option gives the holder the right to sell an asset at a fixed price on or before a certain date.
When Investors Use It
Put options are used when an investor expects the price of an asset to fall.
Simple Example
If the share price falls to USD 25, the investor sells at USD 38.
Profit = (38 − 25) − 2 = USD 11
If the price stays above USD 38, the option expires unused and the investor loses only the premium.
Are Options Enforceable Rights? (Conventional Finance)
Yes, in conventional finance, options are legally enforceable rights:
This enforceability is what gives options their financial value.
Mechanism of Options (Step-by-Step)
Islamic Finance Perspective on Options
In Islamic finance, conventional options are generally not permissible because:
However, Shari’ah-compliant alternatives exist.
Non-Enforceable (Waʿd-Based) Structures in Islamic Finance
Instead of enforceable options, Islamic finance uses unilateral promises (waʿd):
Example (Islamic Hedging)
A bank promises to sell a commodity at a fixed price in the future if the client requests it. The client is not trading the promise itself, but using it for risk protection.
Key Differences to Remember
Core Takeaway
Call options protect against rising prices, put options protect against falling prices. In conventional markets, options are enforceable rights. In Islamic finance, enforceable options are replaced by Shari’ah-compliant promise-based mechanisms to avoid speculation and uncertainty.
What Is an Option (General Idea)
An option is a financial contract that gives the holder a right, but not an obligation, to buy or sell an underlying asset at a predetermined price (called the strike price) within a specified period. The seller (writer) of the option has the obligation to fulfil the contract if the holder chooses to exercise the option.
Call Option
Meaning
A call option gives the holder the right to buy an asset at a fixed price on or before a certain date.
When Investors Use It
Call options are used when an investor expects the price of an asset to increase.
Simple Example
- Current share price of Company A: USD 50
- Call option strike price: USD 55
- Option premium paid: USD 3
If the share price rises to USD 70, the investor exercises the call option and buys at USD 55.
Profit = (70 − 55) − 3 = USD 12
If the price stays below USD 55, the investor does not exercise the option and loses only the premium of USD 3.
Put Option
Meaning
A put option gives the holder the right to sell an asset at a fixed price on or before a certain date.
When Investors Use It
Put options are used when an investor expects the price of an asset to fall.
Simple Example
- Current share price of Company B: USD 40
- Put option strike price: USD 38
- Option premium paid: USD 2
If the share price falls to USD 25, the investor sells at USD 38.
Profit = (38 − 25) − 2 = USD 11
If the price stays above USD 38, the option expires unused and the investor loses only the premium.
Are Options Enforceable Rights? (Conventional Finance)
Yes, in conventional finance, options are legally enforceable rights:
- The option holder has the right, not the obligation, to exercise
- The option writer has the legal obligation to honour the contract if exercised
This enforceability is what gives options their financial value.
Mechanism of Options (Step-by-Step)
- Buyer pays a premium to the option seller
- Option contract specifies strike price and expiry date
- Market price moves
- Buyer decides whether to exercise or let the option expire
- If exercised, seller must fulfil the contract
Islamic Finance Perspective on Options
In Islamic finance, conventional options are generally not permissible because:
- They involve excessive uncertainty (gharar)
- They resemble gambling (maisir)
- The option itself is traded without ownership of the underlying asset
However, Shari’ah-compliant alternatives exist.
Non-Enforceable (Waʿd-Based) Structures in Islamic Finance
Instead of enforceable options, Islamic finance uses unilateral promises (waʿd):
- One party makes a promise to buy or sell in the future
- The promise is morally binding, not always legally enforceable
- No premium is charged for mere promise
Example (Islamic Hedging)
A bank promises to sell a commodity at a fixed price in the future if the client requests it. The client is not trading the promise itself, but using it for risk protection.
Key Differences to Remember
- Conventional options: enforceable rights, premium-based, speculative
- Islamic alternatives: promise-based (waʿd), asset-linked, risk-mitigating
- Purpose in Islamic finance: protection (hedging), not speculation
Core Takeaway
Call options protect against rising prices, put options protect against falling prices. In conventional markets, options are enforceable rights. In Islamic finance, enforceable options are replaced by Shari’ah-compliant promise-based mechanisms to avoid speculation and uncertainty.
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