Option contracts are among the most important instruments of financial derivatives because they pave the way for investors to hedge against risks in an environment characterized by risk and uncertainty. Options also enable investors to speculate using financial leverage. Meanwhile, some profess option contracts to have transformed from being risk contracts into contracts for hedging against risks while actually still maintaining the same risk. This is because options are nothing but gambling tools for trading in risks, due to being sold and bought by being transferred from those who are hedging against them to those who accept them with a desire to obtain the fee for taking on the risk.

In light of many Arab countries’ (especially Gulf countries) inclination toward implementing option contracts in their financial markets while maintaining Shariah compliance, this study intends to discuss the Shariah ruling regarding these contracts from the perspective of Islamic economics. The study relies on inductive and deductive approaches to discuss the concept of option contracts, their origin, development, types, and Islam’s view toward them.

The study defines an option contract as a contract between two parties, one being the holder or buyer of the contract and the other being the issuer or seller of the contract. Under this contract, the buyer has the right to buy from or sell to the issuer a number of units of a real or a financial asset at a specific price agreed upon in advance during the contract initiation on the condition that the execution will take place at a later date (i.e., the execution or expiration date). The buyer has the right not to execute the contract if this execution is not in their best interest. In exchange, a compensation payment is made to the issuer, called a reward or premium, during the contract initiation phase. This premium is neither refundable nor a part of the transaction value.

The study also discusses the types of option contracts and categorizes them according to various considerations. In terms of the type of transaction, option contracts can be divided into a call option, a put option, or a double option. In call options, the investor (buyer of the option) has the right to buy a number of financial securities (or other) at a specified price on a certain date in return for a premium paid by the buyer to the issuer of the option. In put options, the investor (buyer of the option) has the right to sell a number of financial securities (or other) at a specified price on a certain date in exchange for a premium paid by the buyer to the issuer of the option. In double options, the investor (the purchaser of the option) has the right to buy and sell a number of financial securities at a specified price on a specific date in return for a premium paid by the buyer to the issuer of the option, thus combining both the call and put options under one contract.

In terms of ownership of securities, option contracts can be divided into covered and uncovered options. In the covered option, the contract issuer (seller) owns the underlying securities of the contract or has sufficient cash to meet their obligations if the request is made to execute the contract and the contract is a put option. In the uncovered option, however, the option seller does not have enough of the underlying securities from the contract to allow them to fulfill their obligations upon a request to execute the contract and deliver the underlying asset if the contract is a call option or lacks sufficient cash to meet their obligations if the contract is a put option.

In terms of contract execution date, option contracts can be divided into American options and European options. In American options, the option buyer has the power to exercise or execute it at any time during the period from the conclusion of the contract until the expiry date. The European option, however, is an option contract that can only be exercised or executed on the contract’s specified expiry date. Namely, the expiry/execution date is the last valid day of the contract (i.e., the third Friday of the month of execution/expiry).

The study also presents the emergence and development of option contracts, as they have been known for hundreds of years. In the 19th century, traders in the United States called them privileges, but these were traded in an unorganized market only among people who knew each other in a city. Meanwhile, the first organized market for trading in option contract shares was established at the Chicago Stock Exchange in April 1973. Through this, options were traded in the organized market only after being traded over the counter.

The study seeks to find out the ruling on option contracts in light of Islamic Shariah based on their depiction. This requires identifying the rights in Islamic Shariah by considering how an option gives not an obligation but a right to its purchaser and by identifying the named contracts that can be viewed as being in agreement with option contracts. In addition, the study includes a discussion on considering option contracts as new and unnamed contracts.

The right in option contracts is shown to not originally be an inherited right for the seller but rather one created through the contract for the benefit of the buyer. Furthermore, after its creation, the right is not associated with wealth but with the abstract aspect of buying or selling. If selling Shariah-mandated rights such as Haq al-Shufa’ah [right of preemption] and Haq al-Qisas [right of retribution] is not permissible unless they are associated with wealth, then selling rights not mandated by Shariah (e.g., options) is impermissible a fortiori.

Furthermore, option contracts are not the same as the permissible Salam contract, because the price in option contracts is not paid during the contract initiation phase but rather delayed until the execution date and done through settlement of price differences. According to the opinion of the majority of scholars on Salam contracts, however, the price must be paid during contract initiation, or within a period of no more than three days according to the Maliki scholars. Moreover, the underlying asset in the option contract is sold several times while in the possession of the first seller and before the first buyer takes possession of it with the aim being to receive or pay the price differences, while selling the item before receiving it is not permissible in the Salam contract.

Option contracts are also not the same as sales that use Bai’ al-Urbun [down payment contract], which Imam Ahmad approved of, unlike the view of the majority. This is because the down payment is part of the price of the commodity. However, the option premium is a liability or an obligation that represents the price of the option itself separate from the price of the asset. Additionally, the subject matter (i.e., commodity) is present in the sale using Bai’ al-Urbun. As for the option contract, the subject matter does not exist. Furthermore, the right in option contracts may be for the buyer or for the seller, while in sales using Bai’ al-Urbun, the right is only granted to the buyer. In addition, option contracts are tradable, while sales using Bai’ al-Urbun are not. The objective of option contracts is not to attain the purpose of the contract (i.e., receipt of the price and the subject matter), but rather to benefit from the price differences. However, in sales using Bai’ al-Urbun, the purpose of the contract is achieved by delivering the remainder of the price and receiving the commodity.

Option contracts are also unlike sale contracts in which Khiyar al-shart [right of cancelation] is stipulated, for option contracts are independent of sale contracts, while Khiyar al-shart has no independent existence. It is related to the sale contract itself and its subject matter is a specific commodity. Moreover, the subject matter of option contracts is a mere right, not a real or financial asset, while the subject matter of contracts in Khiyar al-shart is an existing commodity. Lastly, options are tradable, whereas a Khiyar al-shart is not.

An option contract cannot be considered as a new unnamed contract in order to be legitimate in Shariah. Although the general rule in Islamic transactions is permissibility, applying this maxim should not go against the fundamentals of the Shariah. Charging money in exchange for granting options can be considered the same as attaining people’s wealth unlawfully. Also, option contracts are undoubtedly of the Gharar [ambiguity] and gambling types. They also involve usury, and all of these are prohibited by Islamic law. They also violate the objective of sale-based contracts, which is to grant ownership. Options contracts also fall under the sale of what one does not have or possess as well as Ba’i al-kali bil kali [sale of debt]. Options also go against the maxim of justice, which is the cornerstone of contracts, because the interests of the contracting parties clearly collide as the benefit of one party is, at the same time, a loss for the other. 

Although option contracts in their current forms are impermissible, Islam does not forbid anything without having multiple permissible alternatives in its place. Creativity and good innovation in worldly matters are required and desirable as long as they are disciplined through religious commands. Therefore, no objection exists toward finding Shariah compliant alternatives to option contracts, provided that they are targeted toward hedging against price movements and not for speculation. This should be done by avoiding resorting to the use of patchworked rulings to provide Shariah excuses; being blameworthy by copying, imitating, or using tricks; or using Satanic financial engineering. This is done by avoiding things Sharia consider impermissible such as Riba [usury] and Gharar, selling what is not owned, or delaying the possession of countervalues to initiate a debt with another debt,. This is also done in addition to being reasonable regarding the core objectives and holistic matters in Islamic economics by basing Shariah rulings on partial and holistic matters as well as the core and minor objectives. 

This can be achieved by basing sales using Bai’ al-Urbun [down payment contract], Shariah-approved rights, and the binding promise without trading them. This ensures achieving the actual delivery and possession of the assets, be it real or financial, while avoiding gambling. This also realizes the interests of both contracting parties without having a zero-sum game. Ultimately, this is beneficial to the national economy.