The idea of conventional‘options’does exist in the Islamic commercial law, albeit it is distinct from the above described concept of options attached to a sale contract.
As mentioned before an option in Islamic finance is affiliated to a sale contract (and to other permissible contracts which are optionable). The option is part of the conditions of the sale and not separable from it.
Thus, it cannot have a price of its own and it cannot be traded separately. An option is defined, therefore, as giving the right to one of the contracting parties (or both) to follow through with or call off the contract within a specified period of time (El Gari 1991: 31). Therefore, acceptance of the proposal to sell or buy is allowed for a period of time, which is equivalent to the period of the option given.
According to Abu Hanifa the period is 3 days, but the majority of the other three schools of thoughts’scholars allow an‘appropriate’length of time, which could be more or less than 3 days. According to El Gari (1991: 32) the idea of options in 142 9 Options Contracts as an Underlying Product of Financial Engineering in. . .
Shariah is not unrelated to the stock market options. The dissimilarities, however, are enormous:
Firstly, stock market options create a right (enjoyed by the buyer) and an obligation maintained by the seller. They are independent contracts autonomous from the sale or purchase of the underlying stocks.
Secondly, even if we say that options are new contracts and that Shariah does not restrict transactions to only standard contracts, we need to determine the per- missibility to ascertain the subject matter of this contract. The underlying construct in an option contract is a‘right’and an‘obligation’that are sold and traded in the market. The problem here is that Shariah does not recognise these abstract matters to be the substitute of a sale contract in the process of financial engineering of an Islamic alternative to options to be used in IFIs. Though some rights in Shariah are subject to inheritance and some are subject to cash settle- ment, such as the right of the wife on her husband in case of divorce, but they are not transferable to a third party through a sale transaction. Therefore, a market for option trading as it stands would not be acceptable under Shariah.
Thirdly, if we assume that the option contract is not separable from the sale contract of the underlying stock, i.e. the naked options. We are still faced with the problem of paired contractual obligations; the transaction consists of two sale contracts in one, which results in the invalidity of both (El Gari 1991: 32).
9.12.1 Call Option
Many traders in call options operate without intending to exercise them, but to profit from changes in market price. Furthermore, some option writers sell what is called
‘naked option’, i.e. writing options on stocks they do not own, just for the purpose of making profit. Options as a speculative device are, clearly, unacceptable in form of contract under Shariah. One, nevertheless, should not overextend the definition of speculation. There are many legitimate uses of options in stock markets. In particular, the hedging aspect of options is quite in line with the recognized needs of individuals and IFIs, which is not contradictory to Shariah. The problem remains, however, that an option contract should not have an independent existence of a sale or lease contracts. This means that what is paid for an option is part of the total sale price of the underlying goods or asset.
There is, however, one form of sale contract in Islamic jurisprudence which allows an option at a price. The sale of down payment or advance (‘arbun) allows the buyer to advance a small percentage of the agreed upon price so that he can have time to decide. If this decision was not on the affirmative, then this advanced payment is kept by the seller. It is worth noting here that the option is only for the buyer, the seller is obliged to honour his commitment. This shows that the amount paid, while it is a percentage of the total price, it is in reality a price of the option (see Radwa¯n 1996; El Gari 1991; Kamali 2000). It is noteworthy, that what
has been suggested, as a financial engineering solution for options, on the basis of a down payment is in accordance with the Hanbali School of jurisprudence, but not the other three schools.
9.12.2 Put Option
Put options are contracts which give their owners the right to sell a specified stock at a set price within a given time period. An investor who expects prices to decrease can sell a put to protect his investment. If expectation takes place he can exercise the contract. Hence, selling above the market price, which has gone down, while there is, obviously, plenty of space for speculators, the need for such a contract is legitimate in most cases. Once more, the substance of the put option is not the underlying stock, but the right and obligation of properties which are not compliant with Shariah.
9.12.3 Index Option
If the purpose of transacting in stock markets, from savers point of view, is to profit and since the latter depends on ability to predict the direction of the market, then there is no need to buy and sell. Rather, it is sufficient to cash the difference between what is expected and what really took place. It is because of this index options are quite popular, where one can speculate on the whole market, as if he buys and sells every stock in the exchange market. Obviously, this is pure gambling.
What one buys or sells, when he buys an index option, is a chance to win an amount of money not specified (the difference between current price and future price). Gambling in Shariah is not permissible even for charitable purposes, not mentioning profit making. Buyers and sellers of options are not necessarily part of the shareholders of the corporation and, as such, may not be participating in any way in the running of the underlying corporation. They are essentially betting on the expected performance of the corporation in very much the same way gamblers bet on horses in horse racing (see Radwa¯n 1996). There is a clear difference between the two. In the option case, the gainer and the loser are the investors themselves, not the corporation.
9.12.4 Right as an Object of Sale
The view of some Islamic scholars is that an option is a promise to sell or purchase an item at a specified price within a stipulated time, such a promise in itself is 144 9 Options Contracts as an Underlying Product of Financial Engineering in. . .
permissible. The promise is also binding on the promisor. However, this promise cannot be the subject matter of a sale or purchase contract (Usmani 1996: 10–11).
As the resolution of the Islamic Fiqh Academy, Jeddah (the 7th Session of the Council on 9–14 May 1992) asserts “Option contracts as currently applied in the world financial markets are new types of contracts, which do not come under any one of the Shariah nominated contracts. Since the subject of the contract is neither a sum of money nor a utility or a financial right which may be waived, the contract is not permissible in Shariah”.
One of the counter values in the trading of options is a right or a privilege granted to a party in contrast to a tangible object orma¯l.The scope ofma¯lalso generally includes intangibles, such as a service and usufruct (Obaidullah 1998: 76). The subject matter of an option is a right (haqq) that is pure and simple (al-haqq al-mujarrad). This right is neither a tangible commodity nor a usufruct; it cannot therefore be a proper subject matter of a contract.
There is an argument, however in favour of introducing options trading on other grounds, concurs with this viewpoint. Provided that the right does not have a tangible or material quality, but it is indeed intangible that may not be sold or bought, considering that it is not a property. It is only similar to a preemptive right (shuf’ah, right of custody and guardianship) all of which, while allowed in Shariah, are intangible rights that are not allowed to be sold or relinquished against monetary compensation (Abu Sulayman 1992: 32–33; El-Gari 1993: 13).
A few Islamic scholars however, would prefer to include any kind of benefit (manfa’ah) in the definition ofma¯l. Since options involve a benefit (a right without obligation) for the purchaser, trading of such benefit is observed to be permissible.
Ahmed (1996: 6–15) argues that the Islamic Investment Study Group of the Securities Exchange Commission, Malaysia in its report finds call warrants to be acceptable because it “has the characteristics of an asset. This asset satisfies the concept of tangible right (haqq ma¯li) and right of ownership (haqq tamalluk), which is transferable based on the majority of Islamic jurists’(fuqaha’) views other than the Hanafi School. Therefore this right can be classified as an asset and can, consequently, be traded.