Before we go into whether options are Halal or Haram, let’s make sure we understand what options are.
There are two types of options:
1. Call options
A call option is a financial contract that gives you the right, but not the obligation, to buy an asset at a certain price.
E.g. Company XYZ shares are trading for $100/share. A call option may give me the right to buy the company at 101$ a share for the next month.
This means the option will only be exercised if the price of the share rises to above $101. If the price of the underlying stock remains below $101 for the next month, the option will expire worthless.
Why use a call option?
Hedging risk. If you need to buy a particular asset in the future and you want to hedge the risk of the price going up in the future, a call option can eliminate this risk for you.
E.g. Let’s say you represent a multinational corporation and you know you’re going to need to buy 1 million barrels of oil over the next year. Currently, the price of a barrel of oil is $50. If the price of a barrel of oil goes above $60 your company is in big trouble. So you want to hedge this risk.
To do this, you can buy a call option that allows you to buy oil for $60 a barrel over the next year.
Speculating on price. Another reason why you might buy a call option is to speculate on the price of the asset.
E.g. if I think that oil is going to be above $60 a barrel, I can buy a call option and the higher the price of a barrel of oil gets, the more valuable my call option will become.
2. Put Options
A put option gives the holder the right, but not the obligation, to sell an asset at a certain price.
Why use a put option?
Hedging Risk. If you own a particular asset which you intend on selling and you want to hedge the risk of it’s price going down, a put option will allow you to do this.
E.g. You represent a multinational corporation and you know that you are going to sell 1,000,000 barrels of oil over the next year. Currently the price of a barrel is $50 but if it drops to below $40 a barrel your company is in trouble. In this case, you can buy a put option that will allow you to sell your oil at $40 even if the market price drops below $40. So you’ve eliminated part of the price risk of selling oil.
Speculating on price. E.g. if I think that oil is going to fall below $40 a barrel, I can buy a put option which allows me to sell at $40 and the lower the price of a barrel of oil gets, the more valuable my put option will become.
Halal or Haram?
I’ll tell you what I think and then you can make up your own mind. I don’t represent anyone but myself so make sure you take the opinions of multiple sources before you reach a conclusion.
Allah SWT prohibits something called Al Maysir. In the generous Quran 5:90-91 , the translation of what SWT says is:
“O you who believe, intoxicants, Maysir, sacrificing for idols and making decisions based on games of chance are sicknesses from the work of Satan, so avoid these things so you may prosper. Satan desires to create enmity and hatred amongst you through intoxicants and Maysir and to stop you from praying and remembering Allah. So will you abstain from these things?”
The Holy Quran 5:90-91
As I pointed out in a previous video, Maysir is defined as an activity where the following two conditions are met:
- Participants are risking wealth in hopes of material gain.i.e. They are creating risk.
- There are no prospects for creating any value from the activity.
A prime example of Maysir is gambling in a casino. When players gamble, they are risking their money in hopes of material gain (first condition) and their act of gambling carries no prospects of producing anything beneficial for anyone (second condition).
Keep in mind, when I say “beneficial” I am referring to usefulness. Money is not useful in and of itself, rather, it is a means for transacting in that which is useful.
As mentioned earlier, options can either be used to hedge risk or to speculate on price.
When using options to hedge risk i.e. transfer a certain risk from the bearer of this risk to another party more able to assume this risk, this creates value.
Suppose you had a backpack full of rocks that was wearing on you and you were able to transfer your backpack to someone else with a stronger back that had no problem carrying your rock-filled backpack for a fee. This creates value.
You get the backpack full of rocks off of your back and the stronger individual is able to monetize their strength by carrying your backpack.
When options contracts are used to hedge risk, the backpack full of rocks represents risk and the options contract represents the mechanism by which the backpack full of rocks is transferred from your back to another person more willing and able to carry the weight.
So while condition 1 in identifying Maisir can certainly be said to be true whenever options are being traded, condition 2 which is that there are no prospects for creating any value cannot be said to be true when the options are being used to hedge risk.
However, when options are used to speculate on price, both conditions of Maisir are met and therefore it is prohibited in Islam (haram).
Why is it haram to speculate on the price of options but not haram to speculate on the price of assets e.g. stocks?
Stocks are valuable in and of themselves.
Options fall in the family of financial instruments called derivatives because they derive their value from the price of some other underlying asset.
Let’s say you want to speculate on the price of XYZ company by owning its stock.
XYZ has 10 shares outstanding.
The maximum number of shares of XYZ that can be bought is 10 i.e. the number of XYZ shares outstanding.
However, if you would like to speculate on the price of XYZ shares using options, the maximum number of options that can be bought is infinite. You don’t have to own XYZ stock in order to speculate on its price using options.
You just have to own the options contract which can be written out of thin air.
The possibility for the unchecked creation of risk using options contracts is what necessitates added restrictions on dealing with them.
This is why Warren Buffett referred to derivatives as “financial weapons of mass destruction.”
The reason why it’s halal to speculate on the price of stocks and haram to speculate on the price of options is because when you buy a stock a transfer of risk is happening from the owner to you. Risk is not being created. However, with options that are used to speculate on price, a net creation of risk is happening that can’t be justified by any prospects of creating value.
Those were my two cents on options trading.
Let me know what you think in the comments section below.
If you need halal funding and live in the U.S. check out fundmbebff.com.
I wasn’t to get involved in investing / trading but in this minefield, I’m confused as to what I should dabble into? Forex? Stocks? Day trading, options, futures AAARRRGGHHH!! If only I had received one simple answer I would just stick to it and not waste my time reading about other markets!! OH ALLAH PLEASE HELP!! I JUST WANT TO BETTER MY FAMILIES LIVES AND I KNOW IF I PUT MY MIND TO IT I’LL DO WELL
Of the things you mentioned, Stocks 🙂
Sill lost trying to understand at what point it’s halal or Haram.
Is collecting premium from a vertical put/call spread halal or haram? I want to use this premium as a means of passive income. in regards to risk- when using a vertical spread the risk is calculated to the dollar and so is the net profit. This seems the safest way to be involved in the market. Is this halal or haram? please shed some light on this specific strategy of option trading.
Curious to see Rakaan’s thoughts on this as well. Including selling covered calls/wheel strategy
Although I understand what you’re saying, not sure I agree. There is a transfer of risk on a long call/put which is the cost of purchasing the option…that amount of money is the defined and maximum risk. The gain is not entirely based on ‘speculation’ like in gambling at the casino. At the casino, it is a ‘game’ of chance…you hope the dice will land on 7 or the cards will be 21 or the roulette wheel will stop on red. In options, if you are using technical analysis and various indicators (and have invested time and money in educating yourself), then using options is based on some education. News (like a new product launch or M&A) will create change that cannot be incorporated. Regarding ‘value’, one could strongly argue that if the long call/put or even vertical goes in your favour, then the gains are used for creating value in the person’s life – such as buying food, clothing, zakat, housing, etc… That money that is spent on food also helps the grocery store pay wages and also goes to the farmer…the trickle down of the gains creates value for many. So in my opinion, trading options whether long/short positions or verticals is halal.
1-Just because the risk is limited to the purchase price of the option, doesn’t mean this risk wasn’t created with no corresponding value to justify this creation.
2-As for whether options are a game of chance or not, this is completely irrelevant to the question of whether or not it is gambling. Poker is a game that involves alot of skill. In fact you could argue that poker is entirely a matter of skill since everyone pretty much receives the same cards in the course of 1000 hands. However, because poker involves putting your money at risk with no corresponding value creation it is gambling.
3-You could make the same argument for any type of haram income earning activity. For example, I play poker to make money and I use that money to feed my family therefore I am creating value through my playing of poker. No. Feeding your family is halal. Earning money through poker is not. Regardless of what you do with the proceeds. And Allah knows best.
Thanks for the reply…but;
1 – if we follow this argument, then nothing is created without risk with no corresponding value. A company could make a sofa at a cost of $100 and sell it for $150. Their risk is $100. But if the sofa does not sell at $150, they reduce the price to $100 – the break-even. Even then, say it doesn’t sell, they keep reducing the price to, say $75 or $25 and the sofa company is now in a loss position and no value has been created. Switch the word ‘sofa’ for ‘option’ and it’s the same way an option trades.
2- poker and options are different. You need 1000 hands for everyone to have the same cards before ‘skill’ is involved. With options, everyone has the same ‘cards’ immediately and there is no waiting for 1000 hands for everyone to be made equal. If anything, one could argue that everyone is dealt the same cards in options and it is your skill whether to buy/sell an option. Your skill determines whether to ‘play’ the option.
3- an accepted definition of ‘value creation’ would be good. For some, putting food on the table is value creation and agree that this is halal. But to buy the food, then cook it with gas/electricity one needs money. So being able to buy/sell an option and exit profitably is value creation. Otherwise, the many Muslims that work for non-Islamic banks or financial institutions or software companies or media companies or food companies or are earning haram money.
The value being created using options is defined. So maybe long calls/puts are not halal because there is unlimited gain even though the risk is clearly defined. But spreads have a defined risk and a defined profit at the time of entering the trade.
Short puts are haram because 1) not owning the underlying asset….just borrowing it and 2) undefined risk and 3) there’s an interest cost of using margin.
You forgot to mention that the seller of the call or put…that is the one who was given the bag of rock to carry on his back, can simply decide not to carry it anymore by closing his option. That is He Buy to Close his contract.
Please try to understand the options contract dealing from beginning to end before writing.
Try to understand fully what is Sell to Open, Buy to Close. Buy to Open, Sell to Close. About Rolling the contracts.
This are all choices of an option contract that can be exercised anytime by buyer or seller.
Like I said, I can choose not to carry your rocks on my back by buying back my contract as and when I so wishes.
The option contract can only proceed when both the seller and buyer agreed to proceed, if not, either seller or buyer can terminate and close their option contract anyrime they so wishes. HALF BAKED KNOWLEDGE is dangerous and unwelcomed.
Unfortunately it is difficult to understand the complete argument of your comment.
One the one hand you say “The option contract can only proceed when both the seller and buyer agreed to proceed” and then say “IF NOT” “either seller or buyer can terminate and close their option contract anyrime they so wishes”. The “IF NOT” is crucial because it implies that the buyer and seller may not agree and therefore the contract cannot proceed.
This is incorrect.
The seller (or buyer) of an option can close their position but only if there is a willing participant on the other side of the trade – a willing buyer (or seller). So these 2 parties MUST agree on a price and when they do, the contract is closed. So there is ALWAYS an agreement between buyer and seller in an option contract at any point in time.
Whether opening a trade or closing a trade – there MUST be an agreement between buyer and seller.
You need to be clearer whether you are discussing long option positions or spreads or short option positions or something else.
As you correctly state, half-baked knowledge is dangerous and unwelcome. Perhaps you should consider further educating yourself? We are here to help.
Have you ever trade options before ? Eg : Before you sell or buy an option, you checked on the open interest first. Do you know what open interest is ? Let’s assume you knew. So I will proceed.
You SELL TO OPEN an option from your laptop, let’s say on TESLA through your broker then it will be send to the OCC ( do you know what OCC is ? Have you traded options before ? ) who will matched your sell order to a buyer.
The buyer ( no idea who they are ) will be matched to you by the OCC machine.
You collected the premiums.
As and when you decided that you wanted to EXIT THE TRADE, you select BUY TO CLOSE on your laptop… through your broker trading platform….and it will be send to OCC who will matched you with a Seller ( don’t know who he is ..all randomly selected by the OCC machine ) …
Within seconds your contract WILL BE CLOSED.
Are you sure you have traded options before ? Your questions sounds like you need help in understanding options trading principles and technologies. Just a tip…it is A MACHINE that matched buyer and seller, it is why OPEN INTEREST is important.
I don’t need your help in anyway though, thank you very much. It is best that you advised yourself to bake yourself.
Ali, your comments are petty and immature. Let’s bring the conversation to an adult-level.
Your initial comment stated “…can simply decide not to carry it anymore by closing his option”.
If you have a long position and there is no open interest….and you decide to close the contract, you CANNOT because there is no one on the other side of the trade. So the OCC can send the order, but it will not fill because there is no one on the other side to complete the trade.
Even if there is just a handful of Open Interest, the bid/ask spread will likely be so wide that you’ll close at such a loss if you put a LMT order in. If you put a MKT order…well, then you don’t know what you’re doing and should not be trading options.
Not sure whether you just paper-trade or are talking theory….try it in real life. Enter a position where there is little to no Open Interest and then try to close the trade.
Then come back and share your experience.
In the meantime, have a wonderful day!
I have few things regarding Options trading. If I am wrong then please correct me.
1) Whether Stock or Option they are not speculative or you can say it depends on the trader if he/she is not able to understand the Technicalities behind trading then it becomes speculative for him/her. But for those who understand fundamentals and technical things they are predicting future price value.
2) Let me clear this.. “Underlying asset is not owned by you so its haraam to sell call/put to others
Hadith that is generally referred to is that if you do NOT own that thing you have no right to sell it. Here I should say that TODAY’s financial system is different and this hadith cannot or should not be applied to today’s markets. This hadith, for my understanding, was/is for those cheaters/thieves in those days who use to sell sheeps and camels to others even though they did not own them. But here this Financial system is different and whole world know underlying asset may not be yours.
3) It is not win-win scenario. One has to definitely lose money at the end.
While this scenario is true when it comes to gambling in casino, it is not true here in Options. People may be writing call/put to HEDGE risk and even if Option seller might lose money in call/put but his/her stock value might be increasing. So overall there might be NET profit for Option seller while even buyer might be making profit.
Salaam,
I really like the framework you’ve put around this discussion by defining Maysir with the twin conditions of creation of risk and non-creation of value. I’m still reading up and considering whether or not this is truly a sufficient definition, but I hope to be swayed.
One outstanding question I have is with regards to the distinction you’ve drawn between speculating on the price of assets and speculating on the price of an options contract (or other derivatives). The distinction seems artificial for the following reasons:
1/ The argument hinges on the speculation on asset price not creating risk. This is untrue, surely. Market participants speculating can create a bubble, and that certainly does increase total risk of the participants. If I buy a stock from the previous owner at 2x the price he or she bought it at, with no corresponding increase in the value of the underlying asset, that is risk creation.
2/ The prior issue notwithstanding, your argument also somewhat hinges on the notion that since there are a fixed number of shares outstanding (the float), the total risk is constant. My comment above indicates that the conclusion is incorrect, but I also believe the premise is flawed. Companies can issue more stock “out of thin air”. You may then argue that it is the company that engages in the unlawful when they create stock, but it is fine to trade these stocks once they are created, but that is tantamount to saying you can trade options once they’ve already been written.
In sum, I think the distinction you’ve created between speculating on stocks and options is a little arbitrary – a stock is a ‘derivative’, in a sense, just as much as an option is. I think a little more thinking needs to be done to make sense of this, but please point out if I’ve missed something.
JazakAllah khayr for your insights!
Salam
Are stocks rights and warrants considered the same as options?
I think everyone is missing the point, speculating on option pricing is irrelevant because no one on this blog is an actual derivatives trader and has a sophisticated model enough to see where implied volatility is cheap or not and trade. The majority of people here are using options to hedge their stock positions.
I highly doubt anyone is selling/underwriting outright options considering the substantial risk that comes with it and the fact doing so without a hedge in place is the definition of risking unlimited wealth for small material gain, that in itself is gambling.
If you are trading butterflies or straddles/strangles which set the amount you can lose (by the max of all the premiums you paid) then this seems okay.
In any case to be able to trade options you’d actually need a meaningful amount of money in your broker account (100k+) and enough margin.
Trading CFDs or binary options is without a doubt haram as you do not own any part of the asset.
I think you need to break it down into are you owning something or not, as options are physically deliverable you do own the right to buy/sell the stock at a specified date and price or to sell it. So by that logic it’s allowed.
As convoluted as this all sounds, if you do not understand something don’t trade it. And please guys do not trade levered products without understanding the risks involved, there is a reason why 80% of retail traders lose money trading with CFD brokers. Instead invest a portion of money in halal ways with a diverse range of stocks with the intention that if you lose half of your portfolio you will still be fine because key point here you still have a income from a normal day job.
The best traders are not those that are super levered with a get rich quick mentality but are making small gains on a daily basis using intellect and understanding the products they trade and the news that affects them.
At the end of the day Allah knows best, happy to field any questions from you guys, I’m not a sheikh by any means but I am an actual investment banker that worked at the top American/European Investment banks (not in ops but actually front office) and have become increasingly more diligent in what is deemed as halal and haram in financial markets.
Here is my question and would really appreciate your response.
If I do not want to own a stock that I really like, using the option trade of selling cash covered Put to collect the premium for that stock is halal in your opinion? Say, if I really want to buy a stock at a lower price that I’m comfortable with and have enough money to take the advantage of using the option trade strategy, cash covered Put and eventually close out of the position after the expiration date and collect the premium. This way I thought if the stock price drastically goes up, I can collect extra income and still have a chance to buy my favorite stock at a lower cost if the stock price went drastically down. Please let me know your honest thoughts/opinion before I start doing something which may not inline with the teaching of Quran/Sunnah. Thank you and Jazak Allah khiran!
I mean if I do want to own a stock that I really like, using the option trade of selling cash covered Put to collect the premium for that stock is halal in your opinion?