Is Options Trading Halal or Haram?

To answer the question, “are options halal or haram?” let’s make sure we understand some key definitions:

Generally speaking, there are two types of options:

Call Options

These are financial contracts that give holders the right, but not the obligation, to buy an asset at a certain price.

For example, Johnson & Johnson shares (JNJ) trade for $100/share.

A call option may give its holder the right to buy JNJ for $110/share for the next month. 

This means the option will only hold intrinsic value if the price of JNJ rises above $110/share within the next month. Otherwise, the option expires with no value.

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 during your buying window, a call option can limit this risk for you.

For example, you represent a multinational corporation and are concerned that the price of oil rising above $60 per barrel within the next year will be detrimental to your company.

To hedge this risk, you can purchase a call option that allows you to buy oil for $60 per barrel at any time in the coming year. This will protect you in case oil prices rise above your $60 threshold during this period.

Speculating on Price

Call options can be used to speculate on the price of the underlying asset.

For example, if you believe that the price of oil will rise above $60 per barrel in the coming year, purchasing a call option that allows you to buy oil for $60 per barrel at any time in that period could be a profitable decision.

If the price of oil does indeed rise above $60, the option will gain intrinsic value, with its worth increasing as the price of oil goes up.

However, if the price of oil reaches $70 per barrel, your right to buy at $60 per barrel will have an intrinsic value of $10.

Put Options

These are financial contracts that give 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 that you intend on selling and you want to hedge the risk of your asset’s price going down, a put option will allow you to do this. 

For example, you represent an oil corporation and are aware that selling 1 million barrels of oil for less than $40/barrel within the next year could cause problems for your company.

To mitigate this risk, you can purchase a put option that allows you to sell your oil for $40 per barrel even if the market price drops below that level. This will protect you from the negative consequences of oil prices falling below your $40/barrel threshold.

Speculating on Price

Put options can be used to speculate on the price of the underlying asset.

For example, if you believe that the price of oil will drop below $40 per barrel in the coming year, purchasing a put option that allows you to sell oil for $40 per barrel at any time in that period could be a profitable decision.

If the price of oil does indeed fall below $40, the option will gain intrinsic value, with its worth increasing as the price of oil goes down.

However, if the price of oil falls to $30 per barrel, your right to sell at $40 per barrel will have an intrinsic value of $10.

Is Options Trading a Form of Al-Maisir (Gambling)?

In the generous Quran 5:90-91, a translation of what Allah (SWT) says is:

O you who believe, indeed, intoxicants, Al-Maisir, [sacrificing on] stone altars, and divining arrows are but defilement from the work of Satan, so avoid them so that you may prosper. Satan wants to cause enmity and hatred between you through intoxicants and Al-Maisir and to avert you from the remembrance of Allah and from prayer so will you abstain from these things?

The Holy Quran 5:90-91

Al-Maisir is present in zero-sum games involving money.

These zero-sum games:

1. Don’t produce anything useful (a good or service).
2. Create enmity and hatred between participants since one party’s gain is necessarily the other party’s loss.

A prime example of Al-Maisir is gambling in a casino.

When players gamble, they are risking their money in a zero-sum game wherein nothing useful is created while animosity and hatred is sown between the competing sides of the gamble.

As it relates to options and their similarity with gambling…

Are Options Useful?

They can be.

When options are used to transfer a specific risk to a more willing and able party, this is useful.

Suppose you are carrying a heavy backpack, and it is causing you strain.

A person with a strong back offers to carry your heavy backpack for a fee.

Is this person’s service useful to you? certainly.

You relieve yourself of the heavy backpack, and the strong-backed person is able to earn money by carrying it for you.

The heavy backpack in our analogy represents risk and the options contract serves as the mechanism for transferring the risk from one party to another party who is more willing and able to bear it.

This is how options can be useful.

Are Options Always Useful?

No.

When neither side actually owns the asset, there is no risk transfer and therefore no usefulness.

There is no heavy backpack changing shoulders.

The backpack doesn’t even exist before the option contract is written.

In this case, the option contract is merely a financial bet between two parties devoid of practical usefulness.

Additionally, since one party’s gain is the other party’s loss, enmity is sown between the opposing sides of the contract.

Therefore I assess the case of options trading wherein neither buyer or seller actually owns the underlying asset to be a form of prohibited al-maisir.

I would venture to guess that the vast majority of options contracts available to retail investors fall in this category.

How Is Options Trading Different From Stock Trading?

Stocks represent ownership in a company and have intrinsic value. When you purchase a stock, you assume the risk of ownership from the previous owner.

There is no new risk being created when stocks are traded, only risk transfers.

On the other hand, options derive their value from their underlying asset. Hence their classification as Derivatives.

An options contract written without an underlying asset creates new risk, this risk is essentially “created out of thin air.”

This is why Warren Buffett referred to derivatives as “financial weapons of mass destruction.”

Consider the following example…

Let’s say you want to speculate on the price of XYZ company by owning its stock. 

If XYZ has 10 shares outstanding, the maximum number of XYZ shares anyone can buy is 10.

However, with options, you can potentially buy an unlimited number of contracts on those same 10 shares.

This means there is the potential for unlimited risk creation using options. This is why it is necessary to have additional restrictions in place to manage this risk creation.

Conclusion: When Does Options Trading Become Al-Maisir?

In short I assess options to be indistinguishable from prohibited Al-Maisir when they create risk and halal when they are used to transfer risk.

Now let’s apply this understanding to some of the most common option trades:

Buying Calls

When a call option is bought, the buyer of the option obtains the right, but not the obligation, to buy a certain quantity of the underlying asset at a predetermined price (the strike price) at any time on or before the expiration date of the option.

Is Risk Created?

If the seller holds the underlying asset, the price risk is transferred from the seller to the buyer in the amount of the price of the sold call.

E.g. Adam owns a $100 share of Tesla. Therefore Adam is at risk of losing $100 by continuing to hold Tesla. If Adam Sells a call option on his share for $5, then the maximum Adam can lose from holding the Tesla share is $95 ($100-$5). Therefore by selling a Call, Adam partially transferred the risk of ownership to the Call Option buyer.

If the seller doesn’t hold the asset, then no risk is transferred, only created.

Halal or Haram?

If the seller holds the underlying asset, Halal.

If the seller doesn’t hold the underlying asset, Haram.

Buying Puts

When a put option is bought, the buyer of the option obtains the right, but not the obligation, to sell a certain quantity of the underlying asset at a predetermined price (the strike price) at any time on or before the expiration date of the option.

Is Risk Created?

If the buyer owns the Put’s underlying asset, risk is transferred from the option buyer to the seller.

If the buyer doesn’t own the asset, then no risk is transferred, only created.

Halal or Haram?

If the buyer owns the Put’s underlying asset, halal.

If the buyer doesn’t own the Put’s underlying asset, haram.

Selling Naked Calls

Selling a Naked Call happens when the investor sells a call option without owning the underlying asset.

The seller of a Naked Call option has unlimited potential loss since there is no limit on how high the price of an asset can reach.

Is Risk Created?

Naked calls don’t have associated assets, therefore, new risk is created everytime a Naked Call option is written.

Halal or Haram?

Haram.

Selling Naked Puts

Selling a Naked Put happens when the investor writes, or sells, put options without holding a short position in the underlying security.

Is Risk Created?

If the buyer holds the underlying asset, the price risk is transferred from the buyer to the seller.

If the buyer doesn’t hold the asset, then no risk is transferred, only created.

Halal or Haram?

If the buyer holds the underlying asset then it’s halal.

If the buyer doesn’t hold the underlying asset then it’s haram.

Selling Covered Calls?

A covered call is an options strategy in which an investor holds a long position in an asset and sells call options on that same asset in order to generate income from the options premiums. This strategy is considered “covered” because the investor already owns the underlying asset, so they have the underlying stock to sell if the call options are exercised.

Is Risk Created?

No. The options are associated with actual assets. The option seller has partially transferred the price risk of their shares to the buyer in the amount of the price of the sold call.

E.g. Adam owns a $100 share of Tesla. Therefore Adam is at risk of losing $100 by continuing to hold Tesla. If Adam Sells a call option on his share for $5, then the maximum Adam can lose from holding the Tesla share is $95 ($100-$5). Therefore by selling a Call, Adam partially transferred the price risk of his shares to the Call Option buyer.

Halal or Haram?

Halal.

Selling Cash-Covered Puts

A cash-covered put is an options strategy in which an investor sells a put option while simultaneously setting aside the capital needed to purchase the underlying stock at the option’s strike price.

Is Risk Created?

When the buyer owns the Put’s underlying asset, risk is transferred from the option buyer to the seller.

When the buyer doesn’t own the Put’s underlying asset, no existing risk is transferred, only new risk is created.

Halal or Haram?

When the buyer owns the Put’s underlying asset, halal.

When the buyer doesn’t own the Put’s underlying asset, haram.

A Summary of Is Trading Options Halal or Haram?

Option Strategy	Is Risk Created or Transferred?	Verdict (My assessment only)
Buying Calls	Transferred if the seller owns the underlying asset. Created if the seller doesn’t own the underlying asset.	Halal when seller owns underlying asset Haram when seller doesn’t own underlying asset.
Buying Puts	Transferred if the buyer owns the underlying asset. Created if buyer doesn’t own underlying asset.	Halal when buyer owns underlying asset Haram when buyer doesn’t own underlying asset.
Selling Naked Calls	Created	Haram
Selling Naked Puts	Transferred if the buyer owns the underlying asset. Created if buyer doesn’t own underlying asset.	Halal when buyer owns underlying asset Haram when buyer doesn’t own underlying asset.
Selling Covered Calls	Transferred	Halal
Selling Cash-Covered Puts	Transferred if the buyer owns the underlying asset. Created if buyer doesn’t own underlying asset.	Halal when buyer owns underlying asset Haram when buyer doesn’t own underlying asset.

When you are trading options on stocks, for example, you have no visibility into whether or not the option is associated with an asset or not. 

So then the only case when it becomes permissible to deal with options is if you own the asset.

So either your own the asset 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 the right to buy it from you, a call (or a right to buy). This is also called a covered call.

Final Thoughts

For all the scenarios I didn’t cover, just ask yourself, is risk being transferred or created? If the options trade is creating risk then it is haram. Transferring risk is halal.

Those were my two cents on options trading anyway and Allah swt knows best.