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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​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 – 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 – Introduction 
  • Futures contracts = agreements to fix prices before actual delivery of goods/services
  • Used by producers & commercial operators to manage transactions in advance
  • Key benefits:
    • Reduce multiple types of risk (price uncertainty, market fluctuations)
    • Support production planning (agriculture, industry, commerce)
    • Enable large-scale marketing & trade efficiency
  • Market operation:
    • Contracts typically arranged by Mohammad Hashim Kamali (1999) notes:
      • Qualified brokers/agents involved
      • Must follow strict, centralized market rules
  • Supervision & security:
    • Trading monitored by clearinghouses
    • Ensure financial stability & solvency of traders
    • Highlighted by Mohsin S. Khan (1988)
  • Overall role:
    • Improve market organization
    • Enhance confidence in future transactions




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Islamic Derivatives – Issues with Futures Contracts  
  • General view:
    • Muslim scholars have differing opinions
    • Many argue futures contracts do not fully comply with Shari’ah principles


1. Absence of Countervalues at Contract Stage
  • No immediate payment and no delivery of goods/services
  • Transaction exists only on paper (speculative intent)
  • Shari’ah requirement:
    • At least one countervalue must be present for validity
  • Comparison with Salam:
    • Buyer pays in advance
    • Seller delivers later
  • Issue:
    • Futures defer both payment and delivery, which is not permitted


2. Short Selling (Selling Without Ownership)
  • Seller sells commodities not owned or possessed
  • Violates principle:
    • Sale must involve transfer of ownership
  • Ownership cannot transfer if seller does not own the asset


3. Lack of Actual Possession Before Resale
  • Many futures trades occur without physical delivery
  • Shari’ah requires:
    • Ownership and possession before resale
  • This condition is often not fulfilled


4. Sale of Debt for Debt (Prohibited)
  • Both payment and delivery are deferred
  • Results in:
    • Bai al-kali bil-kali
  • This type of transaction is prohibited in Shari’ah


5. Speculation, Gambling, and Uncertainty
  • High level of speculation in futures markets
  • Linked to:
    • Maisir (gambling)
    • Gharar (uncertainty)
  • Both are strictly prohibited
  • Can lead to:
    • Price volatility in real markets


Overall Conclusion
  • Key concerns:
    • Lack of ownership
    • Deferred countervalues
    • Speculative nature
  • These issues make conventional futures contracts problematic under Islamic law

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​Islamic Derivatives – Bai al-Kali bil-Kali (Debt for Debt)
  • Definition:
    • Bai al-kali bil-kali refers to:
      • A transaction where both countervalues are deferred
      • In simple terms: exchanging one debt for another debt


  • How it works:
    • Buyer promises to pay later
    • Seller promises to deliver later
    • At the time of contract:
      • No money is paid
      • No goods are delivered
    • Result → both sides hold future obligations (debts)


  • Why it is prohibited in Islam:
    • No real exchange at the time of agreement
    • Leads to:
      • Uncertainty (gharar)
      • Higher risk of default or dispute
    • Goes against Shari’ah requirement:
      • At least one countervalue must be immediate


  • Key Shari’ah concern:
    • Contracts should involve certainty and fairness
    • Debt-for-debt creates:
      • Weak contractual foundation
      • Potential for speculation and exploitation


  • Simple example:
    • A sells goods to B:
      • Payment: after 3 months
      • Delivery: after 3 months
    • → Nothing exchanged now → both are debts → prohibited


  • Contrast with permissible contracts:
    • Salam:
      • Payment made upfront
      • Delivery later
      • Only one side deferred → allowed
    • Murabaha:
      • Goods are owned and sold with known cost and profit
      • Clear structure → permissible


Key takeaway:
  • Bai al-kali bil-kali = both sides deferred
  • Considered invalid in Shari’ah
  • One of the main reasons why conventional futures contracts are problematic in Islamic finance

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​Islamic Derivatives – What is “Debt” in Islam?
  • Basic meaning:
    • Debt (Arabic: dayn) = an obligation owed by one party to another
    • It can be:
      • Money owed
      • Goods or services owed (to be delivered later)


  • Key characteristics of debt in Islam:
    • It is a binding responsibility that must be fulfilled
    • Created when:
      • Payment is delayed, or
      • Delivery of goods/services is postponed
    • Recognized and regulated under Islamic commercial law (fiqh al-muamalat)


  • Examples:
    • Borrowing money → you must repay later
    • Buying goods now, paying later → price becomes a debt
    • Paying now, receiving goods later (like Salam) → goods become a debt on the seller


  • Important rules in Islam:
    • Debt must be:
      • Clearly defined (amount, time, terms)
      • Free from injustice or exploitation
    • Charging interest (riba) on debt is strictly prohibited
    • Debts should be:
      • Repaid on time
      • Written/documented (encouraged in the Qur’an)


  • Connection to futures contracts:
    • In cases like Bai al-kali bil-kali:
      • Both sides (payment & delivery) become debts
    • This is problematic because:
      • Islam discourages exchanging one debt for another


Simple takeaway:
  • A debt in Islam is anything owed and deferred
  • It is taken seriously, must be fair, and should not involve interest or excessive uncertainty

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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 – 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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