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Stock Options

By Mufti Taqi Usmani

Q.) I need to know if the following share trading is permissible in Islam.

Share options give you the right to buy or sell a share at a certain price within a fixed time period. You pay for the option but you don't have to exercise it. You can also buy options on future contracts, interest rates and currencies in the same way. The price you pay for the option is called the 'premium', and the price at which it is agreed that you may buy or sell the shares or futures contract is called the 'exercise price' in the UK. The price that you pay for an option depends upon the period of time allowed until the option expires(the longer it is the more expensive the option), and also upon the difference between the 'exercise price' and the current market price of the shares or futures contract.

Options give you leverage. All you have to pay is the price of the premium to make a bet that the exercise price will be better than the market price at some point before the option runs out. You don't have to come up with any more money unless you already know you have won your bet. There are two kinds of options, 'puts' and 'calls'. A call option gives you the right to buy, and a put option gives you the right to sell. Traded options enable you to buy or sell your option if you win the bet, instead of buying the shares or other securities themselves.


Call Option:

Suppose you think that shares in Company X are going to go up in the next three months. You can buy a three-month call option on 1,000 shares at, say, 184p; the premium will be 18p per share, so you will pay 180 pounds plus dealing costs for 1,000 shares. If the share price is at 187p after 3 months, you could exercise the option to buy in the hope that the share price will continue to rise; you will have spent 180 + 1,840 = 2020 pounds, so, not counting dealing costs, the shares will have to rise above 202p for you to make a profit.

Put Option:

Suppose that you think Company X's shares are going to go down in the next three months. You can buy a put option for 18p per share for 1,000 shares at 184p. if the shares go down to, say, 150p, you can exercise your option by 'putting' it on to an option dealer, forcing him to buy your shares for 1,840 pounds, which you now exercise your right to buy for 1,500 pounds, and pass them on to him. The cost to you, not including dealing charges, is 1,500 + 180 = 1,680 pounds, so your profit is 1,840 -1,680 =160 pounds. Since your broker can conduct both transactions quickly, you won't have to come up with all the money to buy the shares.

A.) The trading of options as in vogue in the stock markets and as explained by you in your questions is not permissible in Shariah. Firstly, because the option is not something tangible which can be bought or sold and secondly, because this transaction has an element of Gharar or Qimar (gambling). Besides, these derivatives have brought negative results on the economy. For details you may consult the book: APOCALYPSE ROULETTE: THE LETHAL WORLD OF DERIVATIVES by Richard Thomson published by Macmillan Publishers Ltd, London, 1998.

    Albalagh Home Q & A Stock Options
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