Option Trading be good or bad and if they can’t be when are they good according to different religion?

Understanding of Option Trading

First let’s understand what Option Trading are. Option Trading give their holders the right but not the obligation to buy or sell something for a certain price for a certain period of time. So for example if an apple costs a dollar and you think that the price of apples is going to go up an options contract can give you the right but not the obligation to buy an apple for a dollar for the next six months.

for example. If the price of apples actually does go up during this period and let’s say it reaches two dollars per apple and you have the option to buy apples for a dollar then you can use that option to buy an apple for a dollar and then sell it on the market for two dollars and make yourself a one dollar profit. Or alternatively if you don’t want to get into buying and selling and you don’t want to go through that trouble you can just sell your option to buy the apple for a dollar to someone else.

By the way if you’d like me to teach you how to navigate the markets in a good or bad conscious ,Back to our apples. So is all of what happened good? First why are we even questioning the permissibly of this? I mean trade is good we know that trade is good so why is there a question mark here? Well trading options is different from let’s say trading stocks because stocks are valuable in and of themselves.

On the other hand options are only valuable to the extent that the underlying asset is valuable. So if I had an option to buy a particular apple and that apple rotted and lost its value my option to buy that apple would become completely worthless.

My option to buy the apple derives its value from the value of the apple and that’s why options are called derivatives because they aren’t valuable in and of themselves rather they derive their value from the underlying asset. Now why would this necessitate special consideration? Well the danger of options is that when they are written without an underlying asset they’re essentially creating risks out of thin air and this is why Warren Buffett referred to derivatives as financial destruction.

Example for Option Trading

Consider the following example let’s say you want to speculate on the price of XYZ through owning its stock and let’s say in total there are only 10 shares of XYZ so the maximum amount you’re able to speculate on the options you can potentially buy an unlimited number of contracts on those same 10 shares. This means that there is the potential for unlimited risk creation using options and this is why options and derivatives in general require special considerations and additional restrictions because they allow potentially for the unlimited creation of risk.

Fortunately, Islam prohibits risk creation that doesn’t have any prospects of creating anything useful, good or a service that brings about value. This prohibition is evidenced by the prohibition of al -Maysr or gambling.Therefore, it is logical to conclude that options are prohibited when they create risk as opposed to transferring it like what happens in normal trade.

So to ascertain when Option Trading are prohibited to use, we need to simply ascertain when are these options creating risk and simply put options create risk when they’re not associated with an asset. When Option Trading are associated with an asset, the risk is transferred from one party to the other. When they aren’t associated with an asset, risk is being created out of thin air. When you are trading options on stocks, for example, you have no visibility into what the other side of the trade actually owns. So then the only case when it becomes permissible in my assessment to deal with options is if you yourself own the asset.

So either you own the asset in Option Trading and you’re buying a put or a right to sell. This is also called a protective put. Or you own the asset and you’re selling a right to buy it from you or a call. And this strategy is called a covered call. Frankly, in Option Trading these are the only two cases I can think of where dealing with options in the context of the stock market would be permissible because these are cases where you’re able to verify that risk is being transferred from yourself as the asset owner to the option buyer.

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In Option Trading everything else I’m uncomfortable with because there is no way to verify that there is an asset involved in the options transaction. In other words, there’s no way to verify that we’re not engaged.