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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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KembaraXtra – Islamic Derivatives: Do Banking and Capital Markets Both Belong to the Financial System?










🔹 Short Answer




👉 Yes, both banking and capital markets are part of the financial system ✅








🔹 1. What is the Financial System?




👉 The financial system is the overall structure that:


  • Moves money from savers (surplus units)
  • To borrowers/investors (deficit units)




✔ Supports economic activity








🔹 2. Main Components of the Financial System






✔ 1. Banking System (Money Market Side)




  • Deals with:
    • Deposits
    • Loans

  • Focus: short-term financing










✔ 2. Capital Market




  • Deals with:
    • Shares
    • Sukuk/Bonds
    • Derivatives

  • Focus: long-term financing










🔹 3. Key Difference (Important)




  • Banking:
    • Intermediary (bank stands in between)
    • Short-term funds

  • Capital Market:
    • Direct financing (investor → company)
    • Long-term funds











🔹 4. Simple Structure




👉 Financial System includes:


  • Banking (money market)
  • Capital market




✔ Both work together








🔹 5. Example




  • You deposit money in bank → bank lends it
  • You buy shares → company uses your money




👉 Both activities:
✔ Move funds in the economy








🔹 Simple Summary




  • Financial system = big system
  • Banking + Capital market = two main parts










🔹 Final Exam Insight




👉 “Both banking and capital markets are integral components of the financial system, with banking facilitating short-term intermediation and capital markets enabling long-term investment and financing.”

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KembaraXtra – Islamic Derivatives: Difference Between Commodity Market, Stock Market & Bond Market


🔹 1. Commodity Market 🌴
 
👉 A commodity market is where physical goods or their contracts are traded
 
🔸 What is traded?
  • Oil
  • Gold
  • Palm oil
  • Agricultural products


🔸 Key Features
  • Based on real goods
  • Can involve:
    • Spot trading (immediate)
    • Futures/derivatives


🔸 Example
  • Buying palm oil or trading palm oil futures


🔹 2. Stock Market 📊
 
👉 A stock market is where shares of companies are traded
 
🔸 What is traded?
  • Shares (equity ownership)


🔸 Key Features
  • Represents ownership in a company
  • Investors earn:
    • Dividends
    • Capital gains


🔸 Example
  • Buying shares of a company


🔹 3. Key Differences (Commodity vs Stock Market)
  • Nature
    • Commodity → physical goods
    • Stock → ownership in company


  • Purpose
    • Commodity → trade goods / hedge price
    • Stock → invest in business


  • Return
    • Commodity → profit from price change
    • Stock → dividends + price increase


  • Ownership
    • Commodity → ownership of goods
    • Stock → ownership of company


🔹 4. What is Bond Market Called?
 
👉 The bond market is called:
 
✔ 
Debt Market


🔸 Why?
  • Bonds represent:
    • Loans (debt)
 
👉 Investors:
  • Lend money
  • Receive interest


🔸 In Islamic Finance
  • Bond market → ❌ not allowed
  • Alternative:
    • ✔ Sukuk market (Islamic capital market)


🔹 5. Simple Structure
 
👉 Capital Market includes:
  • Stock market (equity)
  • Debt market (bond/sukuk)
  • Commodity/derivatives market


🔹 Simple Summary
  • Commodity market → trade goods
  • Stock market → trade ownership
  • Bond market → trade debt (called debt market)


🔹 Final Exam Insight
 
👉 “Commodity markets deal with physical goods, stock markets deal with equity ownership, and bond markets—also known as debt markets—facilitate borrowing and lending of long-term funds.”
 

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KembaraXtra – Islamic Derivatives: Commodity Market vs Derivatives (Physical vs Cash Settlement)


🔹 Key Clarification
 
👉 Commodity market ≠ always derivatives market
 
There are actually two layers:


🔹 1. Physical Commodity Market (Real Trade) 🌴
 
👉 This is the original commodity market
 
✔ What happens:
  • Real goods are bought and sold
  • Physical delivery takes place


🔸 Example
  • You buy 1 ton of palm oil
  • Seller delivers actual palm oil
 
✔ Real asset
✔ Real exchange


🔹 2. Derivatives Market (Based on Commodities) 📉
 
👉 This is what you are referring to
 
✔ What happens:
  • No real goods exchanged
  • Only contracts based on price


🔸 Example
  • Palm oil futures contract
  • At expiry:
    • No delivery
    • Only cash difference paid
 
✔ Financial transaction, not physical trade


🔹 So You Are Correct (But With Refinement)
 
👉 Your statement:
 
“Commodity market does not involve physical goods”
 
❌ Not fully correct
 
👉 Correct version:
 
✔ Commodity market originally involves physical goods
✔ BUT derivatives market (linked to commodities):
  • Often uses cash settlement only


🔹 Why This Happens
 
👉 Modern markets prefer:
  • Speed
  • Convenience
  • No need to handle goods
 
👉 So:
  • Most futures/options → cash-settled


🔹 Why This is Important in Islamic Finance
 
👉 Big issue:
  • Physical market → ✔ acceptable
  • Derivatives (cash settlement) → ❌ problematic


❌ Why problematic?
  • No real asset exchange
  • Pure price speculation
  • Leads to:
    • Gharar
    • Maisir


🔹 Simple Comparison
  • Physical commodity:
    • ✔ Real goods
    • ✔ Delivery
  • Derivatives (commodity-based):
    • ❌ No goods
    • ✔ Cash settlement


🔹 Simple Summary
 
👉 Commodity market has:
  • ✔ Physical trading (real economy)
  • ✔ Derivatives trading (financial contracts)
 
👉 Your idea is correct for:
  • derivatives side only ✅


🔹 Final Insight (Exam Tip)
 
👉 “While commodity markets involve real goods and physical delivery, derivative markets based on commodities often involve cash settlement without actual exchange, raising Shariah concerns.”
 

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KembaraXtra – Islamic Derivatives: What is a Spot Market?


🔹 Definition
 
👉 A spot market is a market where:
  • Assets are bought and sold immediately
  • Payment and delivery happen on the spot (or very soon)


🔹 Key Features
  • ✔ Immediate transaction
  • ✔ Actual ownership transfer
  • ✔ Real asset exchange
  • ✔ No future obligation


🔹 What is Traded in Spot Market?
  • Commodities (gold, oil, palm oil) 🌴
  • Shares 📊
  • Currencies 💱


🔹 Case Example (Commodity)
  • You buy 1 ton of palm oil today
  • You pay today
  • You receive the goods immediately
 
✔ This is a spot transaction


🔹 Case Example (Shares)
  • You buy shares on stock exchange
  • Payment and ownership transfer happen within 1–2 days
 
✔ Still considered spot market


🔹 Spot Market vs Futures Market
  • Spot market:
    • Immediate trade
    • Real delivery ✔
  • Futures market:
    • Trade now, deliver later
    • Often no delivery ❌


🔹 Why Spot Market is Important in Islam
 
👉 Spot transactions are:
  • ✔ Clear
  • ✔ Transparent
  • ✔ Involve real assets
 
👉 So:
✔ Generally Shariah-compliant


🔹 Simple Summary
 
👉 Spot market = buy and sell now, deliver now


🔹 Final Exam Insight
 
👉 “A spot market refers to a market where transactions are settled immediately with prompt delivery and payment, making it consistent with Shariah principles due to its clarity and real asset exchange.”
 

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KembaraXtra – Islamic Derivatives: Are All Markets Spot Markets? (Clarification)


🔹 Short Answer
 
👉 ❌ Not exactly
 
✔ These markets can operate in both spot and non-spot (derivatives) forms


🔹 1. Commodity Market 🌴
 
👉 Can be:
  • ✔ Spot market → buy palm oil and receive immediately
  • ✔ Derivatives market → futures/options (no immediate delivery)
 
✔ So:
👉 Commodity market = spot + derivatives


🔹 2. Stock Market 📊
 
👉 Mostly operates as:
  • ✔ Spot market (buy shares, ownership transferred quickly)
 
BUT also has:
  • ✔ Stock options
  • ✔ Stock futures
 
👉 So:
✔ Stock market = mainly spot, but also derivatives exist


🔹 3. Debt Market (Bond/Sukuk) 📄
 
👉 Usually:
  • ✔ Spot-based transactions (buy and hold instruments)
 
BUT:
  • Can also have derivatives based on bonds
 
👉 So:
✔ Debt market = mainly spot, but derivatives may exist


🔹 4. Derivatives Market 📉
 
👉 This is different:
  • ❌ Not a spot market
  • ✔ Based on future contracts
  • ✔ Often no real delivery


🔹 5. Correct Understanding (Very Important)
 
👉 Markets are classified by what is traded, not by spot/derivative only
  • Commodity market → goods
  • Stock market → shares
  • Debt market → bonds/sukuk
 
👉 Each of these can have:
  • Spot transactions
  • Derivative transactions


🔹 Simple Table
  • Commodity market → spot ✔ / derivatives ✔
  • Stock market → spot ✔ / derivatives ✔
  • Debt market → spot ✔ / derivatives ✔
  • Derivatives market → ❌ not spot


🔹 Key Insight
 
👉 “Spot vs derivatives” is not a type of market
👉 It is a type of transaction within markets


🔹 Simple Summary
  • Your idea is partly correct ✅
  • But more accurate is:
 
👉 Most markets include:
  • Spot trading
  • Derivative trading
 
👉 Only derivatives market is purely non-spot


🔹 Final Exam Insight
 
👉 “Commodity, stock, and debt markets can operate in both spot and derivative forms, whereas the derivatives market exclusively involves non-spot transactions based on future obligations.”
 

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KembaraXtra – Islamic Derivatives: Why Derivatives Market is Considered Financial, Not Commodity


🔹 Key Idea
 
👉 Even though derivatives are based on commodities,
👉 they are considered financial markets because:
 
✔ What is traded = contracts, not actual goods


🔹 1. What is Actually Traded?
 
🔸 Commodity Market
  • Trades real goods
    • Palm oil
    • Gold
    • Oil
 
✔ You get the physical asset


🔸 Derivatives Market
  • Trades contracts (agreements)
 
Examples:
  • Futures
  • Options
  • Warrants
 
❗ You are NOT trading the commodity itself


🔹 2. No Physical Delivery (Most Cases)
 
👉 In derivatives:
  • Usually no real goods are exchanged
  • Only:
    • Price difference
    • Cash settlement
 
✔ So it becomes:
👉 purely financial transaction


🔹 3. Value is Based on Price Movement
 
👉 Profit comes from:
  • Change in price
  • Not from using or owning the asset


🔸 Example
  • Palm oil futures:
    • You don’t receive palm oil
    • You receive RM difference
 
✔ This is financial gain


🔹 4. Purpose is Financial (Not Consumption)
 
👉 Commodity market:
  • Used for:
    • Production
    • Consumption


👉 Derivatives market:
  • Used for:
    • Hedging
    • Speculation
 
✔ Focus = financial risk management


🔹 5. Standardized and Tradable Contracts
 
👉 Derivatives are:
  • Standardized
  • Traded like financial instruments
 
✔ Similar to:
  • Stocks
  • Bonds


🔹 6. Key Insight
 
👉 Even if based on commodities:
  • The underlying asset is secondary
  • The contract itself is primary
 
✔ That’s why it is:
👉 A financial market


🔹 7. Simple Comparison
  • Commodity market:
    • Real goods
    • Physical delivery
  • Derivatives market:
    • Contracts
    • Cash settlement


🔹 Islamic Finance Insight
 
👉 This is why derivatives are problematic:
  • ❌ No real asset exchange
  • ❌ Profit from price movement only
  • ❌ Leads to speculation


🔹 Simple Summary
  • Derivatives market is financial because:
    • ✔ Trades contracts, not goods
    • ✔ Uses cash settlement
    • ✔ Focuses on price movements


🔹 Final Exam Insight
 
👉 “The derivatives market is considered financial rather than a commodity market because it involves trading of financial contracts based on underlying assets, with profits derived from price movements rather than actual exchange of goods.”
 

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KembaraXtra – Islamic Derivatives: Role of Derivatives (Options, Warrants & Futures) in Conventional vs Islamic Finance


🔹 Key Idea
 
👉 In modern finance:
  • Derivatives (options, warrants, futures) are widely used
  • They help investors:
    • Increase returns
    • Manage risk
 
👉 Islamic finance is also growing and trying to:
  • Develop Shariah-compliant alternatives


🔹 1. Why Derivatives Are Important in Conventional Markets
 
✔ 1. Higher Return Opportunities
  • Investors use derivatives to:
    • Gain profit from price movements
    • Use leverage
 
👉 Attracts sophisticated investors


✔ 2. Risk Management (Hedging)
  • Protect against:
    • Price changes
    • Currency fluctuations
 
✔ Important for businesses


✔ 3. Market Innovation
  • Financial markets continuously develop:
    • New structured products
    • Complex instruments
 
👉 Driven by:
  • Investor demand
  • Competition


🔹 2. Why Islamic Finance Is Adopting Them
 
👉 Islamic finance is growing rapidly
  • Investors want:
    • Halal investments
    • Risk management tools
 
👉 So:
✔ Shariah-compliant versions are being developed


🔹 3. Challenge: Converting to Shariah-Compliant
 
👉 Main issue:
  • Conventional derivatives contain:
    • ❌ Gharar (uncertainty)
    • ❌ Maisir (speculation)
    • ❌ No real asset exchange


👉 Therefore, Islamic finance must:
 
✔ Modify structure
✔ Link to real assets
✔ Avoid speculation


🔹 4. Why Understanding Conventional Derivatives is Important
 
👉 Before making Islamic versions:
  • Must understand:
    • How options work
    • How futures work
    • How warrants work
 
✔ Only then can scholars:
  • Identify problems
  • Propose solutions


🔹 5. Key Insight
 
👉 Islamic finance does NOT reject innovation
 
✔ It accepts:
  • Financial development
 
❗ But requires:
  • Compliance with Shariah principles


🔹 Simple Summary
  • Derivatives are important in modern finance
  • Islamic finance is adapting them carefully
  • Must remove:
    • Speculation
    • Uncertainty
  • Must ensure:
    • Real economic activity


🔹 Final Exam Insight
 
👉 “While derivatives play a crucial role in conventional financial markets for risk management and return enhancement, Islamic finance seeks to adapt these instruments into Shariah-compliant forms by eliminating elements of speculation and uncertainty.”
 

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