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OPTION MARKET:
A BANNED PLATFORM UNDER SHARIAH BUT A MUST FOR FDI
Written by:Neha Asif
BBA7 (FINANCE)
01-111142-143

Option markets provide option contracts, which gives the exclusive right to one of two parties,
entitling the bearer to sell or buy something specific in return for a specific price, within a set
period or until a certain date, either directly or through a separate body that guarantees the
rights of both parties.
The prominent in this market are put option and call option contracts. Call option gives the
purchaser the right to go ahead with the purchase or cancel it within a specific period. As for
the seller, he has no right to change his mind about the deal, so long as he has received the price
for this option, which is known as the premium. The purchaser is protected against any rise in
the price of the deal, and the seller gets the premium in addition to the value of the deal at the
time of the contract, if the purchaser goes ahead with the purchase. whereas owner of the put
option have the right to sell a specific number of shares or other financial certificates for a
certain price within a specific period, but he is not obliged to sell, so it is optional. As for the
one who receives the money for this option, he is compelled to buy if the purchaser of this right
decides to sell for the price agreed upon, during the specified time period.
The main objective to own these contracts is not about any specific shares but it is about the
right of ownership. Basically commitments are being sold in these markets with only one of
the buyer or seller is being binded.
It's evident why they seem to be the center of attention in financial circles today. With online
brokerages providing direct access to the options markets through the internet and insanely low
commission costs, the average retail investor now has the ability to use the most powerful tool
in the investment industry just like the pros do. options can provide these advantages to your
portfolio: Greater Cost Efficiency, Less Risk, Higher Potential Returns, and More Strategic
Alternative.
Diverting the talk towards Pakistan ,as PSX initiates process to launch derivatives Analyst
Adnan Sheikh at Topline Securities said currently, there are basic forms of derivatives available
in the market. New products will boost traded value and scale up number of investment
avenues, Sheikh said. This will also open market access to hedge funds trading. Summing
up this will further improve liquidity and provide investors with greater choices in managing
their investment portfolios. (feb19,2017).
when you buy an option, you have a right but not an obligation to do something with it. You
can always let the expiration date go by, at which point the option becomes worthless. If this
happens, however, you lose 100% of your investment, which is the money you used to pay for
the option premium. Second, an option is merely a contract that deals with an underlying asset.
For this reason, options are derivatives. And this could be said as a try ball that investors
always want to play before investing their real money in a foreign economy. Seeing this
perspective Securities and Exchange Commission of Pakistan (SECP) is likely to relax certain
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regulations on stock futures in an attempt to enable the Pakistan Stock Exchange (PSX) to roll
out new derivative products as In January, a Chinese investors-led consortium bought 40
percent stake in the PSXmaking Pakistan the best performing stock market in Asia. The
introduction of derivative products will further improve liquidity and provide investors with
greater choices in managing their investment portfolios.
All happy smooth and ascending growth? It isnt as it seems, Pakistan, a nation with a religion
of Islam as its mainstream faith has a number of arguments that why option/Derivative markets
is a banned platform under Shariah. In regard to this argument following points might be kept
in mind before persuading further.
A financial right that could be compensated with something else is something which has been
involved in ambiguity and gambling by issuing fatwas that it is prohibited to sell or deal in
such contracts and is not permissible according to Islam.
Quoting from Islamic Fiqh Council, no. 63 (1/7):
Option contracts as they are known today in the global financial markets are a new
kind of contract that does not come under the heading of any kind of shari contracts.
Because the object of the contract is not a specific item or benefit, or a financial right
that could be compensated with something else, this type of contract is not permissible
according to Islam. As these contracts are not permissible in the first place, it is not
permissible to deal in them.
Dr. Saami ibn Ibraaheem as-Suwaylim said:
Option contracts that are traded in the global markets, whether they are call options or put
options, come under the heading of ambiguous contracts which are prohibited according to
Islamic teaching. This was stated in a resolution issued by the Islamic Fiqh Council in Jeddah
in 1992 CE, no. 63.
Options are tools of speculation and risk-taking with regard to prices. Therefore this contract
comes under the heading of contracts that made the French economist Maurice Allais describe
the global stock exchanges as huge casinos for gambling, because the essence of gambling
means that one of the two parties gains at the expense of the other, and this is exactly what
happens in the case of option contracts in the international markets.
option contract, is a deferred contract in which one party makes a commitment to the other to
take the risk of price fluctuations during the period of the option contract. Thus the true nature
of the contract is that the one who is offering the option gives a commitment or a guarantee to
the other party to go ahead with the contract at the agreed-upon price. Hence it is a contract in
which one party pays something in order to guarantee the price. Therefore the option contract
is regarded as a kind of insurance contract in reality, and thus it is used as insurance for
investment (portfolio insurance). It is well-known that commercial insurance contracts are
contracts that involve ambiguity, according to the unanimous agreement of fiqh councils.
According to the concept of Option (khiyar) as we find in Shariah literature, the informationally
disadvantaged party at the time of entering into the contract has the option to cancel the contract
within a specified period. A person has also the right to undo his purchase if the seller
specifically allows as part of the terms of the sale. All such forms of option are in the nature of
rights embedded in a contract. In the term khiyar as used in Fiqh books we do not see any
analogy that would lead us to acceptance of the structure of modern option contracts. These are
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independent financial contracts traded for a price that do not have any clear-cut parallel in the
classical Islamic theory of contracts. Khiyar relates to a halal contract of exchange that has
already taken place, whilst a modern option relates to an exchange that is yet to take place. In
the case of khiyar, the exchange of one or both counter values is effected immediately while in
the case of the modern option contract, future delivery applies to both the payment and the
underlying asset. In addition, uncertainty as to the materialization of the exchange exists with
the modern option contract but not in khiyar. A resolution of the Islamic Fiqh Academy of the
OIC asserts, Option contracts as currently applied in the world financial markets are a new
type of contracts which do not come under any of Shariah denominated 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.
Most of the derivatives incorporate gharar (absolute risk), gambling and interest and support
speculative activities. Islamic legal rules, particularly the ban on Gharar and on the sale of debt
for debt, do not allow transactions devoid of real/productive activities. Derivatives involving
such financial contracts which themselves are prohibited in Shariah (Riba based bonds &
forward foreign exchange where mutual exchange is not simultaneous, for example) are clearly
un-acceptable according to the Shariah principles. In case the underlying assets are 3 equities
and commodities it would be seen whether or not Riba and Gharar are involved. Experts are of
the view that even in case of acceptable forms of underlying assets, a key valuation element in
arriving at the fair value of an option contract remains the rate of interest. The Black-Scholes
formula proposes that since an option can be perfectly hedged through constant trading in the
underlying asset, the option position should be riskless and hence earn the buyer the risk free
rate of interest on the premium that was paid for it. (In reality, constant trading of the underlying
asset to achieve the perfect hedge is unattainable, and so option prices behave in ways that are
not entirely predicted by Black-Scholes.) For the unhedged option, the contract becomes one
of pure uncertainty. Neither party knows whether the option would be exercised, as it is
dependent upon the condition of the market at a future date.
Samuel L. Hayes, after detailed discussion on derivatives concludes, There are no effective
derivates of Islamic debt contracts which replicate conventional risk-hedging and leveraging
contracts such as swaps, futures, and options. Similarly, in the equity security sector, there are
no risk-hedging or leveraging contracts in Islamic finance truly comparable to available
conventional derivatives.. With respect to commodities and other goods, the Salam9 contract
is an imperfect Islamic substitute for a conventional forward contract. The related Istisna10
contract for goods being manufactured for a buyer provides another partial Islamic proxy for a
forward contract. It is also possible to construct an Islamic contract which partially replicates
a conventional futures contract, via back-to-back Salam contracts.
Thus we conclude it as yes option markets are a must for FDI but contrarily it is a banned
platform under shariah but still a light of hope can be ignited by the idea of innovation of
Shariah-compliant derivatives contracts that may attract investors who view derivatives as
purely speculative instruments.
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What is option market

Benefits of option markets
Factors effecting option market in Pakistan
Religion; Islam
Relationship between option market and FDI; in context of Pakistan

OIC Fiqh Academy, Seventh session; 9-14 May, 1992

Gharar: It means any element of uncertainty in any business or contract about the subject of
contract or its price, or mere speculative risk. It leads to undue loss to a party and unjustified
enrichment of other, which is prohibited. 7 Arbun: Down payment; a nonrefundable deposit
paid by a buyer retaining a right to confirm or cancel the sale. 8 Vogel, E. Frank & Samuel L.
Hayes, 1998; P.156
- Bai Salam is a contract in which advance payment is made for goods to be delivered
later on. The seller undertakes to s
upply some specific goods to the buyer at a future date in exchange of an advance price fully
paid at the time of contract. The objects of this sale are goods and cannot be gold, silver or
currencies because these are regarded as monetary values exchange of which is covered under
rules of Bai al Sarf where exchange needs to be simultaneous.

(-for further information on shariah complaint derivative contracts background :

https://www.ft.com/content/c5de9b26-5784-11df-b010-00144feab49a )