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Options Trading: Halal or Haram?

There's many ways to invest in asset classes such as commodities or stocks. The most straightforward and common way is to buy the assets directly.

Many traders however invest in financial instruments known as options. Options trading is said to be a potentially lucrative way to get exposure to assets. In this article, we’ll cover:

  1. What are options?

  2. What are they used for?

  3. Are options halal?

  4. The IFG View

What is an option?

An options contract gives the buyer the opportunity to buy or sell an underlying asset for a specific price. This is known as the ‘strike price’. For example, I want to have an option to buy oil at $85 if it reaches $95 or more within the next 30 days. 

For this opportunity, the buyer pays a fee called a premium. The underlying asset can be stocks, commodities, bonds, or currencies. These contracts will also have expiration dates. It’s important to stress that there is no obligation on the buyer to actually buy or sell the asset.

The key benefit here is that if you don't buy the asset because the strike price is not met, even though you lose the fee you paid (the premium), you are still probably better off than if you had bought the assets and then had to sell them at a loss.

What are they used for?

Options have many use cases. In this article, we will focus on the two main ones.

1. Hedging risk

Say you are an investor in Tesla stock but you are worried the price may go down. But you don't want to sell your shares.

If the current share price of Tesla is $1000, you could purchase a put option which gives you the right to sell each Tesla share for $900 in the next year. So even if Tesla stock fell to $200 within 6 months, you would have the right to sell your shares for $900 each. 

If during the coming year, your Tesla shares don’t go below $1000, then you would simply lose the premium you paid for the put option. So using options give you a way to manage your risk.

Options text conversation

2. Speculating on price

Let's take the opposite scenario. You are super bullish on Tesla. You choose to buy an option as you only pay the premium up front and get more (potential) shares for your money.

You buy a call option that gives you the right to buy a certain amount of Tesla stock for $1200 at any time in the next 12 months.

If Tesla stock hits $1300, you might choose to exercise your option, and buy the Tesla stock. You can then sell this on the open market and make $100 per share.

Conversely, if the price stays below $1200, you will have lost the premium you paid to have the option of buying Tesla stock at $1200.

This is just a simple example to illustrate how traders can use options to speculate on price. Needless to say, it’s a lot more complex in the real world with many more variables to consider.

As with other forms of trading, it is difficult to consistently make money trading options. You would need the asset to behave exactly as you predicted before the option contract expires which is no easy feat.

Are options halal?

Options trading is generally seen as impermissible – this was covered on the IFG Fatwa Forum by Mufti Billal Omarjee and Mufti Faraz Adam here.

There are three main points of contention:

  1. The presence of uncertainty (gharar);
  2. Contains an element of gambling (maysir);
  3. The premium charged for options is seen as impermissible.

Gharar

Whether or not an option will be exercised is unknown at the time of agreement. Scholars say the uncertainty present in options amounts to Gharar. You can find a more comprehensive discussion on Gharar here.

Maysir

Furthermore options trading is said to exhibit elements of Maysir (gambling). Both parties to an options transaction enter essentially betting against the other. These scholars liken dealing in option contracts as akin to a game of chance[1].

Issue with premiums

The contention from scholars with charging a fee for option contracts is due to a promise not being a valid subject of sale. This position is supported by the likes of the OIC Islamic Fiqh Academy and Mufti Taqi Usmani[2].

Some scholars have also said there is an element of interest involved when charging a premium as this premium is added to the price of the asset[3]. This is particularly relevant when the underlying asset is a currency.

Opposing view

There is a minority view taken by some scholars that take the position that options trading is permissible.

They believe that options can help enhance liquidity in the market and help in hedging and therefore don’t see it as a form of gambling but something that has real utility. They also see no issue in charging for a promise[4].

An Alternative to Options

Some scholars have advocated the use of Arbun as an alternative to a conventional option [5]. The key difference is in an Arbun contract, instead of paying a premium, a down payment is made.

The buyer then has the choice to complete the rest of the purchase before the contract expires or forfeit the deposit. Arbun thus gives the buyer the choice whether to proceed with a transaction but unlike conventional options, an Arbun cannot be traded.

Another alternative structure used by some Islamic Financial Institutions is a Wa’d. This is a unilateral promise to undertake something in the future but similar to an Arbun, this cannot be traded.

Some organisations charge fees along with the Wa’d structure but the permissibility of this is debated amongst scholars [6].

The IFG View

We have some sympathy for the opposing views – i.e. those views that deem certain options to be permissible. In cases of genuine need, for example currency exchange fluctuations for an international business with global supply chains, a more flexible, lenient approach is advisable.

If you are such a person you should check in with a scholar about your particular circumstances.

If you are speculating on options however, we would recommend against it as there isn’t a burning need and as options trading is a volatile activity that can result in substantial losses.

Conclusion

Options can give investors other ways to hedge risk or make money but in general they are seen to be impermissible.

Permissibility aside, most investors will be suited better by investing for the long term instead of trading. Trading is a skilled profession that takes a lot of work to become really good at and the risks are substantial compared to long term investing.

If you want to learn more about investing, check our Halal Investing 101 Guides.

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