Is Option Contract Haram to Hedge Desired Stocks Value?

Is Option Contract Haram to Hedge Desired Stocks Value

Owning stocks is subject to market price volatility risk, and hence if we use an option contract to hedge such risk, is it permissible in shariah? Before discussing whether a stock option is halal, we should know its nature and why people use it.

What is an option contract?

An option is a contract that allows the buyer the right, but not the obligation, to buy or sell a particular quantity of an asset at a specific price at a future date. The buyer pays the seller a fee known as a premium in exchange for this right. A call option and a put option are the two most common options. In terms of the stock market, a buyer of stock will purchase a put option contract. This protects his stocks against the decline of price in the future. On the opposite, someone watching the potential increasing price of certain stocks will buy the call option. By doing so, he can obtain the desired stock price even below the prevailing market price at the expiration (maturity) date of an option contract.

Why do people use option contract in the stock market?

Generally, there are three purposes of using derivative products, particularly option contracts for stocks. First, people use option contracts to hedge volatility risk in the market. Especially in the stocks market, investors who purchase specific stocks desire their share price to increase. Second, because the option contract is tradable, anyone who does not own the underlying asset could undertake the option contract before its maturity date (expiration). This opens room for speculation in the option contract. Finally, because it is available globally, option contract provides somehow an arbitrage (price differential) opportunity for investors.

Sharia views on option contract

International Fiqh Academy of Organization of Islamic Cooperation issued a resolution ruling the permissibility of options contract. “As currently applied in the global financial markets, options contracts are a new type of contracts that do not fall under any one of the Shariah nominate contracts. Since the object of the contract is neither a sum of money nor a utility or a financial right which may be waived, then the contract is not permissible, according to Shariah. Since these contracts are initially not permissible, neither is their trading. (Resolution no 63/1992)”

However, many scholars observe that an option contract could be classified as earnest money (al-‘Urbun). For example, El Gari (1993) argues that call options are permissible based on the framework of bai-al-urbunBai’ al-urbun is a partial payment of an asset’s price that entitles the buyer to the right to purchase the asset but does not obligate the buyer to do so. If the buyer buys the asset, the urbun is included in the purchase price; if the buyer does not buy the asset, the seller keeps the money as compensation. The payment of urbun grants the buyer the financial right to purchase an asset at a future date for a specific price. Yusuf al-Qardawi maintains that the ruling by Ibn Hanbal on urbun should be adapted to modern times. It is implying that the use of options could be justified on the basis of urbun.

Option contract to hedge desired stock value

Considering that the option contract is in line somehow with bai’ al-urbun, we can say that only hedging purpose is acceptable in sharia for derivative market products. Therefore, the option contract is permissible to hedge the purchase stock against unfavorable prices. On the contrary, it becomes unlawful if it is used to speculate on stock prices. However, it is worth noting that currently, scholars have different opinions on the permissibility of option contracts in the stock market. This is to prevent excessive speculation manners inherently embedded in the option contract trading mechanism. Therefore, following the Shariah principle of preventing harm (sadd al-dzara’i), it is better to stay away from contentious permissibility of option contract.

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