Joe Bradford has an extreme opinion on options. To say the least, his views on options are controversial, as most Islamic scholars deem them haram. Even he admits he is in the minority. Even the ulema who believe Islamic mortgages are fine.. they don’t think options are halal!
Regardless, I’ll explain the rationale on why it’s impermissible.
Some basic questions to ask
Does the seller own the asset before selling?
Does the price stay constant after signing the contract?
If you answered no to either of these questions, the Prophet ﷺ forbade such transactions. Every options contract has at least one of these problems. And most options contracts have both of these problems.
If you are selling something you don’t own, that’s riba. Additionally, if the price of something changes in the future, its called gharar.
For someone to buy something in advance, they have to pay fully in advance with the future date, delivery, and quantity specified. The Prophet ﷺ made this clear. In this case, the buyer is not paying in advance. The buyer is just putting a non-refundable deposit that isn’t part of the selling price.
Related Hadith
The Messenger of Allah ﷺ forbade Gharar and and Hasah transactions.
Messenger of Allah ﷺ said,
“It is not permissible to sell something that is not with you, nor to profit from what you do not possess.”
Is it riba to participate in derivatives trading? (AKA futures, options, and swaps)
Yes.
In Islam, you can make and sign contracts, but you can’t sell contracts.
When people sell the “right to buy” or “right to sell”, they are not selling an asset. They are selling a contract. When you buy and sell contracts, you are exchanging money for money, instead of money for assets. That’s impermissible, as it is just a form of money exchange in the future. Any unequal exchange of money is riba.
In a futures market, no body actually owns the underlying asset. For example, the Chicago Wheat Futures doesn’t actually buy and sell wheat. They are buying and selling contracts to buy wheat. In effect, its just a money exchange. Not a sale of assets.
This type of trading is called derivatives. Derivatives just means contractual agreements. This is why selling all derivatives are haram. Examples of derivatives include swaps, options, or futures market. Another example of a derivative is an agreement to trade a debt for another debt. This is known as securities trading.
Related Hadith
Messenger of Allah ﷺ forbade selling food before measuring it and taking possession of it.
I asked Ibn `Abbas, “Why is that?”
Ibn `Abbas replied, “It will be just like selling money for money, as the foodstuff has not been handed over to the first purchaser who is the present seller.”
Abu Huraira said to [Caliph] Marwan: Have you allowed the transactions involving riba?
Thereupon Marwan said: I have not done that.
Thereupon Abu Huraira said: You allowed transactions with the help of documents only, whereas Allah's Messenger ﷺ forbade the transaction of food grains until full possession is taken of them.
Marwan then addressed the people and forbade them to enter into such transactions (as are done with the help of documents). Sulaiman said: I saw the officers snatching (these documents) from the people.
Basic options terminology
In simple words, a call buyer is betting the price goes up. A put buyer is betting the price goes down. A “covered” option means the seller owns the stock. A “naked” option means the seller does not own the stock.
In every options contract, there are two parties. The seller and the buyer. The buyer pays a premium to the seller. Every options contract involves a hundred shares of the stock.
Example: Using options to bet on Apple stock going up
Peter is selling a call option to Carl. For 100 shares of Apple at $150 strike price for a premium of $50 with an expiration on Friday.
Peter is selling the call. Carl is buying the call. That means Carl is paying Peter the $50 premium. Carl is betting the stock price will be above $150. Peter is betting the stock price will be below $150. Deadline for the bet is Friday.
Say the stock price goes to $160. That means Carl can buy Apple for $150 from Peter. So, Peter loses money because he is losing $10 per share.
Say the stock price never goes above $150. That means Car lost money. Because nothing happened. And Carl paid $50 premium and got nothing in exchange.
Why wouldn’t Carl just buy the stock if he thinks it going to go up?
There are two reasons.
If Apple stock falls a lot, Carl doesn’t lose any money. All he loses is the premium.
Carl doesn’t have to buy Apple stocks upfront. Each Apple share costs $150. A hundred Apple shares would cost $15,000.
What’s the benefit to Peter?
Peter pockets the premium if he is right.
What’s wrong with this from Islamic perspective?
The most obvious problem is that the price is not fixed. And in many cases, these are “naked calls”. That means the seller doesn’t even own the Apple stock, but is selling options on them.
What’s are other options terminology?
“Implied volatility” means how quickly the price is fluctuating. When implied volatility goes up, the premium goes up.
Rolling is a way to get out of the options contract. For example, if the Apple stock price is 145 and there are still two weeks till expiration, the buyer can sell his contract to someone else who is more willing to take the bet. That’s called rolling.
Expiration used to be weeks or months later for the bet. More and more people are doing zero-day expirations options. This means means they are betting on the stock price the next day. In other words, more and more people are getting addicted to betting on the stock price the next day. This phenomenon started after COVID. Why would people do this? Zero-day options means you can make money a lot faster. But they forget, they can lose it all a lot faster too.
The VIX tracks the number of put options with expiration greater than 30 days. In other words, its tracking how many people are betting the stock market will go down in over 30 days. A low VIX would be below 20, and a high VIX would be above 30. And a VIX above 50 indicates incoming crash. It is used to measure fear in the market. However, with the increasing trend of zero-day options, this could convolute the VIX metric.
This is part of my series on Interest Free Zone: All of the Sahih hadith related to riba, A study of weak hadith on riba, Defining riba, A detailed breakdown on why Islamic mortgages are backdoor riba, Do credit card rewards programs have riba?, Madness on options riba
Related, I have a Riba and Ruin series: Economics is to keep you a dummy, What happened to SVB?, Ward of the State, First Republic: A tale of a fake bank & a fake auction, Hush, hush, a small bank goes poof
Related, I have a Selling Islam series: Salaried Shaykhs, Can paid Shaykhs make mistakes?