Islamic Derivatives in Saudi Arabia

Done By:
Khalid Jamal Zaidan: Major Finance, Minor Marketing Mohammed Umair Jafri: Major Finance, Minor Accounting Mohammed Shafiq Abu Laban: Major Finance, Minor Insurance Hisham Raed Kashman: Major Finance Abdul Aziz Mohammed AL-Khudir: Major Finance

SENIOR PROJECT: ISLAMIC DERIVATIVES IN SAUDI ARABIA

AL-YAMAMAH UNIVERSITY

Table of Contents
Acknowledgement........4 Abstract......5 1. Introduction ...6 1.1 What are Derivatives..7 1.2 What is Islamic Finance....10

2. What are Islamic Derivatives...13 3. Forward Contracts....28 3.1 Types of Forward Contracts..33 3.2 Advantages and Disadvantages of Forward Contracts..34 3.3 Islamic Forward Contract.....35

4. Futures Contracts..37 4.1 Types of Futures Contracts42 4.2 Advantages and Disadvantages of Futures Contracts ...43 4.3 Contemporary Futures in the Scope of Islamic Law (Sharia)44 4.4 Islamic Future Contract..46

5. Options Contracts...48 5.1 Basic Trades of Stock Options....49 5.2 Advantages and Disadvantages of options.....53 5.3 Options in the Scope of Islamic Law (Sharia) ...54 5.4 Islamic Option Derivatives......56

6. Recommendations for Islamic Derivatives in Saudi Arabia...58

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7. Conclusion ....61

8. References, Sources and Citation.....63. 9. Index: Glossary of Terms.. 67

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ACKNOWLEDGEMENT
This dissertation would have been impossible without the leadership and the help of several individuals who in one way or another contributed and extended their valuable time, assistance and support in the preparation and completion of this study. We acknowledge the contributions of Dr. Kabir Hasan, a financial economist, consultant in Islamic Finance and an expert in product development and financial engineering. We are also grateful to Mr. Omar Jazar, an investment advisor and a wealth manager in Saudi Fransi Bank.

We would like to thank the Dean of Business College of Al-Yamamah University Dr. Yosser Gadhoum for directing our senior project from its initial stages to finalization. Mr. Mazen Ali for giving us continuous support and encouragement as our dissertation advisor. The faculty of Finance, Economics and Islamic Studies of Al-Yamamah University including Mr. Chadli Belarbi, Mr. Hatim Faris, Dr. Ali Omar, Fayak Akyla, Mr. Anwar Morar and Mr. Ahmad Al-Arif for their continuous support and previous knowledge.

We would also like to thank all the authors of different books, magazines and research papers for making a strong base for our knowledge for completing this project in an efficient and a productive manner. Last but not the least our family members and our friends for sharing their insights and giving moral support for completion of this project.

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ABSTRACT
This project is a window to financial engineering in Islamic Derivatives in the Kingdom of Saudi Arabia and its various forms of trading and practices in contrast to traditional derivatives traded all around the world. Islamic derivatives are classical examples of innovative and new financial instruments in the contemporary financial markets however they are yet to be explored and developed in a full-fledged, mature and standardized manner. As an alternative form of investment Islamic derivatives are similar to traditional derivatives, where the inherent values of those instruments are based on certain other assets. It is important to understand the motivation and conditions of Islamic financial derivatives in contrast to conventional ways of dealing and trading derivatives.

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1.

INTRODUCTION
In this research paper, we will explore how we can apply Islamic derivatives in Saudi

Arabia along with its compliance with the Islamic laws (Sharia). The study looks at empirical, legal, naturalistic and most importantly Islamic perspective of how investments in futures, forwards and options can be embedded together to form new forms of Sharia complied derivatives. The methodology used in this research paper is twofold. The two research methods used in this paper are primary and secondary research, where in the former interviews with financial experts, Islamic scholars and other focus groups were conducted and in the later financial magazines, books, publications and with the help of other creative and thoughtful papers provide an intellectual foundation for our study for this research paper.

According to CFA Institute, derivatives are sort of a hypothetical and synthetic financial instruments where the value is based on some other asset classes such as index, commodity, bond and other similar assets.1 Islamic finance has emerged on international financial landscape in a relatively short period of time and we believe that Islamic derivatives are a niche which can be beneficial to all types of hedgers, investor, bankers and society as a whole within the Islamic financial arena. The derivatives market has speculators, hedgers, arbitragers and it is used for price discovery. In this paper we will analyze what are the differences between Islamic and Conventional derivatives.

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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1.1 WHAT ARE DERIVATIVES?

Derivatives is a word which comes from the word derive which means something deduced from logical reasoning of something else. According to Chicago board of trade and Chicago mercantile exchange, derivative is a financial contract where the value of that instruments dependent upon the price of some other asset (underlying), commodity, security or index. Derivatives and alter and shift the price of risk associated with holding and trading various kinds of assets, thereby modifying the return and risk characteristics of portfolios. 2 There are various reasons why derivatives are traded such as hedging, speculation and arbitrage which are going to be discussed in later sessions.

Managers guide to the worlds most powerful financial instruments says that, derivatives are synthetic and only have hypothetical connection to this world compared to people who live in the real world of assets, event, index or other benchmark that they interact with. Derivatives instruments can be standardized contracts or customized contracts with can be traded either over the counter or exchanged traded. 3 The total notional amount outstanding from derivatives according to a recent press release from International SWAPs and Derivatives Association was around $466.8 trillion (US dollars) on June, 2010.4 A table on the next page shows a graphical statistics from the year 1998 to 2007.

3 4

Myra Valladares. (2009). Overview of Derivatives. MRV Associate. Chicago Board of Trade and Chicago Mercantile exchange (CME Group). Johnson. (1999). Derivatives: Managers Guide to the Worlds most powerful financial instruments.

(2010). ISDA. International SWAPs and Derivatives Association Inc.

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Investors can trade derivatives in several ways they can be either over the counter or traded over a specialized trading market like CME Group and Korea Exchange.

Source: Wikipedia.

Based on CFA Institute curriculum guide, an exchange traded derivatives trades on an organized and regulated exchange (e.g. a futures exchange or an options exchange), where the contracts are standardized. An exchange-traded derivatives transaction is not a private transaction but a public transaction. Exchange-traded derivatives have standardized terms (e.g. notional size and expiration date); operate during specific hours; offers performance guarantees through the use of margin and daily marked to market procedures supervised by a clearing house and are overseen by extensive federal and industry regulation.

(2010). Derivatives (Finance). World wealth vs. Derivatives. Wikipedia.

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On the other hand, over the counter (OTC) derivatives does not trade on an exchange and it is sort of a private transaction. OTC derivatives can be fully customized to suit the needs of the parties to the agreement. For example, an investor looking for a derivative that expires in exactly fifty days will like use OTC derivatives. It has high degree of flexibility and customization in contracts, the information is usually not public information regarding prices and the ways in which contracts will be made and it has less federal regulatory oversight to protect market participants from fraud and market manipulation. There is no central exchange to publish all transaction prices and no clearinghouse to minimize credit risk. 6

There are many different types of derivatives instruments used across the world, however due to the nature of this paper and the time constraint we will keep our discussion focused and specific to 3 different types of derivative instruments and in later stages we will discuss these instruments in further detail and in context to the Islamic and Sharia Laws. The 3 types of derivatives will be analyzed and discussed in this senior undergraduate project are: Forwards, Futures and Options.

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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1.2 WHAT IS ISLAMIC FINANCE?

In recent years Islamic finance has emerged on an international financial landscape and has grown significantly in terms of transactions, scope and activity. According to one of the recent books on Islamic Finance, finance is a study of management of funds and Islamic finance is a way by which financial and business transactions are carried out with reference to the principals of Islamic Law Sharia.7 It entails referenced derivations from the Holy Quraan and the Sunnah (habits and usual practices) of the Holy Prophet Muhammad (Peace Be Upon Him). Today, Islamic finance attracts financial institutions, tycoons, multinational companies, corporate firms and customers across the retail spectrum, manufacturing and project financings.

Islamic finance confers to the ways mentioned in the Islamic sculpture and traditions of the last Prophet in Islam. It is an interesting phenomenon because it presents itself as an alternative to conventional finance not only in the Muslim countries but also in Non-Muslim countries.

There are various things which are allowed in Islam and various things which are not allow or considered Haram (Prohibited). The most critical and distinguishing feature of such a system is the prohibition of
The riba that is practiced to increase some people's wealth, does not gain anything at God. But if people give to charity, seeking God's pleasure, these are the ones who receive their reward many fold. (Qur'an 30:39) References from the Holy Quran O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful. (Quran 3:130)

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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riba (interest), which includes the payment and receipt of interest as understood in todays financial markets. 7 To provide one of the examples from the Holy Quran, the justification of riba (interest) is given in the Quranic verses above.

Islamic finance is based on the principal of flourishing the economy and making the society prosperous. Islamic Laws or Sharia are also called fiqh Al-Muamalat (Islamic rules on transactions). The primary sources of reference are Quran and Sunnah and other secondary sources are opinions collectively agreed among Sharia scholars (ijma). Based on a Islamic Banking book, there are various Sharia concepts in Islamic Finance such as Wadiah (Safekeeping), Mudharabah (Profit Sharing), Murabahah (Cost plus), Musharakah (Joint venture), Ijarah (Hire purchase), Wakalah (Agency), Qard (Interest-free loan), Sukuk (Islamic Bonds) and Hibah (Gift).8

The Industry outlook of Islamic finance has grown astonishingly over the past 3 decades especially in the way it has emerged with new financially engineered products. According to Ijlal Alvi, Islamic financial assets are worth $400 billion and money market has a value of 30-50 billion. They have been extensive development in sophisticated corporate banking products, innovative financial solutions to projects and competitive retail offering.9

Banking Info. (2009). Your guide to basic principles of Islamic Banking. What is Islamic Banking? Bank Negara Malaysia. 9 Ijlal Alvi. (ND). Challenges of Islamic Financial Market Development. International Islamic Financial Market. The world Islamic Banking

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Prerequisites for a Sharia Compliant Instruments:

All Islamic financial instruments in general must meet a number of criteria in order to be considered hall (acceptable).At a primary level all financial instruments and transactions must be free of at least the following four items: riba (usury), maysir (gambling), gharar (unnecessary risk) and jahl (ignorance).

1. Riba can be in different forms and is prohibited in all its forms. For example, Riba can also occur when one gets a positive return without taking any risk. 2. Gharar, there appears to be no consensus on what gharar means. It has been taken to mean, unnecessary risk, deception or intentionally induced uncertainty. In the context of financial transactions, gharar could be thought of as looseness of the underlying contract such that one or both parties are uncertain about possible outcomes. 3. Masyir from a financial instrument viewpoint would be one where the outcome is purely dependent on chance alone as in gambling. 4. Jahl refers to ignorance. From a financial transaction viewpoint, it would be unacceptable if one party to the transaction gains because of the other partys ignorance. In addition to these requirements for financial instruments, the sharia has some basic conditions with regards to the sale of an asset (in this case a real asset as opposed to financial assets).

According to the sharia for a sale to be valid, (a) the commodity or underlying asset must currently exist in its physical sellable form and (b) the seller should have legal ownership of the asset in its final form. These conditions for the validity of a sale would obviously render impossible the trading of derivatives.

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2. WHAT ARE ISLAMIC DERIVATIVES?

The Islamic derivatives are a new word for some people. They start to think how you can combine a forbidden thing in Islamic Law. Sharia explains different types of transaction (Maamlat), each transaction used in different way and different situation. Throughout this project, we verify the Islamic transaction (Maamlat) that could be used within the Islamic derivatives. Furthermore, we explain the time to use it and the way to practice within the other solutions that we offered. These transactions are:

1- Murabaha: Murabaha is the sale of commodity at the price that seller has purchased it, with the addition of stated profit known to both the seller and the buyer. It is the cost-plus-profit sale in which the seller expressly discloses the profit. It is based on trust (Amanah), whereby the seller expressly tells the purchaser how much cost he has incurred and how much profit is going to charge. Both Quran and Sunah are permitting sale in general and gives indirect proof of Murabaha. For example from Quraan "and Allah has permitted trade.10

There are three main elements in Murabaha which are: 1. The subject matter: the subject matter in Murabaha transaction involves the product and the selling price.

10

Dennis Estrada. (ND). What is Murabaha Financing. Ezine Articles

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2. The contracting parties: the seller as the financier and the buyer as the customer. 3. Offer and acceptance: the contract of the offer by one party and the acceptance by another party.11

Murabha can do with some conditions which are: Knowing of the initial price of the commodity, if the seller does not examine the initial price the contract is invalid. Knowing of the profit margin for both parties, otherwise it will not be Murabaha. No Rabawi item be involved in the contract because they are prohibited in Islam. These items are gold for gold, silver for silver, wheat for wheat, dates for dates, salt for salt, barley for barley unless the measurements and the calculation are equal. Initial contract must be valid, the traded commodity must be lawfully owned by the seller according to Islamic law. 11 How Murabaha works: If the client defaults in payment at the due date, the price cannot be increased, because one the priced is fixed it can't be increased. If the bank took specific amount of money in case of default, the client should be sure that this amount of money don not goes to the profit of bank. On the other hand, no rescheduling in Murabaha payment because it is not loan. There are some elements considered to be prohibited in Murabaha contract which are: 1. Using Murabaha as document to obtain funds without intension to purchase any specific commodity.

11

Qazi Irfan. (2008). Murabaha Financing vs Lending on Interest. A thin line in making a big difference in understanding of Riba

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2. Entering into a Murayama contract on commodities already purchased by the clients from third party. 12

In some Murabaha contract, the financier ask third party to secure the transaction and that is allowed in Islam. But, the third party will be involved in the operational deal only in case of default in the payment at the due date agreed between the buyer and the financial institution. Also, the third party liability will be part of the agreement, and considered as bank and standing point to grant the financing to the client. 12

12

Qazi Irfan. (2008). Murabaha Financing vs Lending on Interest. A thin line in making a big difference in understanding of Riba

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How Murabaha Works:

Source: Hassan Kabir

1. The buyer of goods defines his needs and negotiates in advance the specifications and

2. Characteristics of the goods with the seller (goods should be permissible and not forbidden (Haram) by the Sharia).

3. The buyer promises to buy the goods from Islamic Bank (IB). The promise could be binding or not depending on the agreement between the two parties.

4. IB enters into a sales contract with the seller. IB buys the goods as agreed between the buyer and the seller (step 1). IB could buy the goods directly (as principal) or could appoint an agent to buy the goods. Usually IB appoints the buyer as its agent to buy the goods.

5. The seller delivers the goods to IB.

6. IB enters into a Murabaha agreement with the buyer and sells back the goods to the buyer at a higher price (price with a mark-up). The second sale is a deferred payment sale or installment credit sale.

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2- Salam: Salam or (Salaf) is defined as the sale or purchase of a deferred commodity in exchange for price paid on the spot. In Salam contract, the price is paid in advanced while the commodity is deferred in future date. Hanbili defined it as the sail whereby the seller undertakes to supply some specific goods to the buyer at future date in exchange for an advanced price fully paid on the spot. Quran and Sunah permitted the Salam contract in indirectly way. Example from Quran, is Surah al-Bakarah (282) Allah says you who believe when you deal with each other in transactions involving future obligations in a fixed period of time, put them in writing}. This verse includes the Salam contract because it is a transaction involving future obligation. Because the delivery of the subject matter of Salam occurs in the future. 13 How Salam Work Diagram:

Source: Hassan Kabir

13

(ND). Bay As Salam. Islamic Finance.

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How Salam work:

The scholars unanimously agree on the permissibility of Salam and there is no disagreement on that. Moreover, Salam is considered as an exception to the general principles and rules of Sharia in business and trade. Also, the permissibility of this contract was based on the needs of farmers, who needed fund to spend on their business. Scholars consider this contract as special form of license to the people to facilities their business. 14

The benefits of Salam contract for both parties: It is beneficial to the seller because he receives the price in advance. It is beneficial to the buyer because normally the price in Salam tense to be lower than the market price compared to a spot sale.

The capital of Salam must pay in full on the spot, the immediate and full payment of the price is necessary. Since the delivery of the goods in Salam is in the future, banks and financial institution are allowed to request the seller to furnish a security, which may be in the form of a guarantee or in the form of a mortgage to cover the risk of non delivery. Furthermore, in the case of default, the guarantor may be asked to deliver the same commodity. Also, if there is a mortgage the buyer of the financier may sell the mortgage property and the sale proceeds can be used either to realize the required commodity by purchasing it from the market, or to recover the price advanced by him. 14

14

(ND). Salam. Financial Islam. All About Islamic Banking and Insurance.

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3- Istisna: Istisna is sail contract between the ultimate buyer (Al Mostasni) and the seller (Sani), whereby the seller based on an order from the ultimate buyer undertakes to have the manufactured or otherwise acquired product (Al Masnoo). The subject matter of the contract will manufactured according to specification and sell it to the ultimate buyer for an agreed upon price and method of settlement whether that be in advance by installment or deferred to a specific future time. It is a condition of the contract that the seller should provide either the row material or the labor. In order for the contract to be valid there are some conditions must be fulfilled these requirements which are: The subject matter or the good to be manufactured must be identified. This includes its kind, type, measure, quality, and quantity or any related specification. The subject matter must be goods that can be manufactured and not commodity. The subject matter can't be an existing item. The manufacturer must undertake to construct, build the subject matter with his own material. The buyer supplies the row material to the manufacturer it will be considered as Ijara not Istisna. 15

The prohibited elements in this contract are as follows: It is prohibited that the subject matter be already in existing at the time of the contract. The subject matter must be identifying by specification, quality and quantity to be manufactured in the future.

15

(ND). Istijrar. Finance Al Islam. Pakistan.

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The price could no increase or decrease because of the increase or decrease in commodity prices or other factors.

The row material of the subject matter are provided by the manufacturer and cont be supplied by the buyer.

It is permitted for the manufacturer to stipulate a condition in the contract agreement of the Istisna that he will not be liable for defects in the subject matter.

In a parallel Istisna, the institution or the bank cannot simply act as financial intermediary between the ultimate buyer and the actual manufacturer to avoid the element or Rib, the two contracts must be indecently contracted. 16

There two types of Istisna: 1. Ordinary Istina: this is the common type of Istina whereby an agreement between the buyer and manufacturer is concluded based on agreed specification and time of delivery in the future. 2. Parallel Istisna: is a contract of two independent contract agreements but inter-related. 16

4- Urbon Urbon is a deposit given to the seller with a condition that if the contract is continued it will be counted in as part of the purchase price, or otherwise it will be for fitted by the seller. There are different goals of Urbon which are: To secure a right, to secure more time, risk mitigation tool and to make profit. 16

16

Kabir and K. Lewis. (2007). Handbook of Islamic Finance. Edward Elgar Publishing Limited. United Kingdom

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How the two types of Istisna work:

Source: Hassan Kabir

Source: Hassan Kabir

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The Basic Rules of Urbon are: Urbon is an amount in paid in lieu of the right given to the buyer to have a waiting period whether to continue or withdraw from the contract. The deposit paid will be considered as part of the purchase price if the buyer decides to proceed with the contract. If the buyer withdraws, the seller will have the right to keep the deposit. 17

The importance of Urbon in the Islamic finance: Urbon is mechanism that allowances the person who is unsure about the benefits of the transaction that he has entered into, to pay a part of his property in order to reserve for himself the right to either continue or revoke the contract. Urbon can be used as a tool for risk mitigation and risk management. There is a compensation for the buyer for his righting and their right given to the buyer without harming the seller. 17

There are two types of Urbon, which are: The first type when is the down payment given by the buyer, this advanced payment will be considered as part of purchased price. If he decides to withdraw from the contract, the advanced payment will be refunded to him. 17 The second type of Urbon is the down payment will be for fitted by the seller, if the purchaser chooses to discontinue the contract.

17

Kabir and K. Lewis. (2007). Handbook of Islamic Finance. Edward Elgar Publishing Limited. United Kingdom

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Imam Ahmad bin Hanbal and the majority of Hanbilies ruled that there is not haram in this sale, even though the period of Urbon is not determined. Some of the Hanbilies have ruled that this type of Urbon is only valid if the waiting period of Urbon is determined. 18

The application of Urbon in the modern practice as follows: Using Urbon in currency exchange: it cont be used in currency exchange because (Saraf) as contract does not accommodate deferment in the exchange and taking position. Urbon in commodities: Urbon can be used in commodity whereby the buyer secure his deal and the potential of loose by using Urbon as tool in his financial transaction. Urbon in leasing: Urbon can be used in leasing as well, and the same hedging mechanism used in sale can be used as well in leasing. Urbon in portfolio management: this can be exercised when the invested fund is divided to three types of investment as follows: 1- The first one goes to short term investment to secure the availability of liquid. 2- The second will be placed in Islamic bonds. 3- The third one will be place in down payment (Urbon) to purchase common stock in a future date which consist of small portion of the portfolio, if the stock is in favor, the manger liquidate Murabha and buy the stock, of the market is not favor he will leave the un exercised and the loose of that be will composited by other portfolio. 18

18

Kabir and K. Lewis. (2007). Handbook of Islamic Finance. Edward Elgar Publishing Limited. United Kingdom

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Tawaroq: Tawaroq in Islamic law is a particular way to be used in order to obtain liquidity needed without getting involved in borrowing on interest. It involved a purchase of an asset as mean obtaining liquidity. Tawaroq by definition is transaction based on the purchasing of commodity on credit and selling it to a person other than the initial seller for lower price on cash. Tawaroq transaction is concluded between three parties, whereby the person who needs liquidity purchases assets from seller on credit basis; subsequently sell it in the market to any potential buyer with lower price other than the original seller. The Motawreq is not looking for business opportunity to make profit, but he is looking to dispose the commodity faster to get the liquidity to fulfill his need and obligation. The purpose of tawraq is not making business and generates profit but to secure cash and liquidity through a valid transaction from Islamic law perspective.19

Conditions required concluding a valid Tawaroq transaction: In order to conclude a valid Tawarq transaction the seller should have the item in his possession at the time of the sale contract. The seller must have the ownership of the subject matter. Tawraq is a sale transaction; therefore it should fulfill the Sharia requirement in sale contract. The second sale in Tawraq transaction should be concluded with buyer other than the original seller.19

19

Siddiqui. (2007). Economics of Tawarrq. How is it mufasid overwhelm Masaliah.

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How to Apply Tawarruq:

Source: Mohammad Amin

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Istijrar: Istijrar contracts are more complicated. They involve two parties: the buyer, which is usually a company seeking financing to purchase an underlying asset, and a financial institution. The financial institution buys the commodity at the existing price and resells it to the company at a price to be paid at a specified date in the future. The actual price at that date depends on the underlying asset's price movement from the day of the contract initiation to the day of maturity. The contract also includes an upper-bound option and a lower-bound option, by which the parties can choose to fix the price at which settlement will occur at any time before contract maturity. 20

How it works:

2) Resells Asset at a price to be determined at a future date A 1) Financial institution buys the assets 2) A company has the option to fix price B

if it falls such that it breaks the lower

bound before date of maturity (put option). 3) B has the option to fix the price of the commodity before the maturity date if the

price of the commodity moves upward to predetermine level (call option).

20

Kabir and K. Lewis. (2007). Handbook of Islamic Finance. Edward Elgar Publishing Limited. United Kingdom

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Wa'ad: Wa'ad is a promise or undertaking. It is unbinding and has no value; however, in certain circumstances a promise will be valuable and binding. The OIC fiqh puts the following requirements for a wa'ad to be binding: 1. It must be unilateral. 2. It must have caused the promise to have incurred some costs/liabilities. 3. If the promise is to purchase something, then the actual sale must take place at the appointed time by the exchange of offer and acceptance. Mere promise itself should not be taken as the concluded sale. 4. If the promissory reneges, the court may force them to either purchase the commodity or pay actual damages to the seller. The actual damages will include the actual losses suffered by the promise and will not include the opportunity lost. 21

21

Siti Razali. (ND). The concept of Waad in Islamic Financial Contract. Dept. of Business Administration. Kulliyah.

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3. FORWARD CONTRACTS
It is a non standardized contract, which occurs between two parties (buyer and seller) on a trading (underlying) asset, at a known forward time and at a price that is agreed on it today. It does not cost anything to enter forward contact. This contract as future contract has a long position and a short position. However, it differs from the future contract in the names, in which the price that is agreed on today is called delivery price.22

More specifically, forward contracts are done through over the counter market (OTC), meaning the trading is done through a network that is linked with the dealer markets. Investors in the OTC market trade via telephone or internet that linked with the network of that market. Trading forward contract in OTC market has high volume of trading; however the risk in such market is very high risk. For this reason, OTC market is not a standardized market and trades can be customized and tailored to meet the need of the sellers and buyers.

The Uses of Forward Contract: Investors go for forward contracts to purchase or sell the value based on certain assets without adding any direct cost. According to Wiki Invest "This feature makes it attractive to many corporate treasurers, who can use forward contracts to lock in a profit margin, lock in an interest rate, assist in cash planning, or ensure supply of scarce resources". 23

22 23

(2011). Forward Contract. The Free Encyclopedia. Wikipedia. (2011). Forward Contract. Wiki Invest.

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In addition speculators use forward contracts to gain and to maximize their profits and at the same time they are willing to take high risks, opposite to hedgers who look for the stable income with the minimum risk. Many corporations and banks are going for forward contracts to hedge risk. For this reason they can lock prices to avoid the fluctuations of the products. These are the usual agreements that happen between the corporations and the suppliers. These types of investors try to avoid huge changes in the price and are satisfied with a stable income for the suppliers.

How Do A Forward Contracts Work? In Al-Yamamah derivatives class with Mr. Mazen Ali, we defined the forward contract as a contract or an agreement to buy or to sell a value derived from known assets at a certain future date for a certain price. The contact parties will be obliged to perform or exercise the contract at the expiration date or in between maturity and initial, depending on American futures and European futures. To be more professional in speaking we have two sides in the contract the long position and short position.

The long position is the buy position where it is assumed that a contract will be purchased for the value of certain assets for a certain price at a forward date. On the other hand in the short position the seller is assuming to sell a certain assets for a certain price at forward date.24

24

(2011). Forward Contract. The Free Encyclopedia. Wikipedia.

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How Pay Offs Are Calculated? The pay off in such contract is known as sub zero game in which either the buyer or the seller is gaining or loosing. If the long position party gained, the short position party will face a loss and vice versa. To make it more clear, if the spot price is higher than the forward contract price this mean that the one who is performing long position will gain and short position will lose. Therefore, the buyer (long position) buys the value of assets with a price that is lower than the market and the seller needs to sell it with a price lower than the market, to gain economic gains. On the other hand, if the price of the assets (strike price) is lower than the forward contract price, then the buyer (long position) will lose and the seller (short position) will gain. 25
Source Wikipedia 13 Source Wikipedia 13

25

(2011). Forward Contract. The Free Encyclopedia. Wikipedia.

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The value of forward option at maturity is more dependable on the relationship the delivery price (K) and the underlying price (ST) at the same time. We have two types' long payoffs and short payoffs.

Long Position Payoff: fT = ST K . Short Position Payoff: fT = K ST

The delivery price is the price agreed upon, which is equal to the forward price at the time the contract is entered into. In a forward contracts agreement there is always a seller and a buyer, who together agree upon a particular price, contractual agreements, quantity, and date in the future on which exchange is going to happen. At the date of the maturity of the contract, the buyer (long position holder) pays the seller (short position holder) the price which was initially agreed and then the buyer receives the agreed upon quantity of the asset. 26

Here is an example Suppose that Khalid wants to buy Al-Bilad Bank stock of 1000 shares, where the price is equal SR100, 00 per stock today and he wants to buy it a year from now. At the same time, suppose that Ahmad currently owns Al-Bilad stocks with a value of SR 100,000 today that he wishes to sell a year from now. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of SR104, 000 (more below on why the sale price should be this amount).

26

(2011). Forward Contract. The Free Encyclopedia. Wikipedia.

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Khalid and Ahmad have entered into a forward contract. Khalid, because he is buying the underlying stock, is said to have entered a long forward contract. Conversely, Ahmad will have the short forward contract. Now suppose that after a year from now the stock prices was 110,000 and the swap contract was about 104,000 as agreed on between them. Then Ahmad is obliged to sell the stock to Khalid with SR. 104,000 in which Khalid has made a profit of 6000 and Ahmad has made a potential loss of $6,000, and an actual profit of $4,000.

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3.1 TYPES OF FORWARD CONTRACTS

1. Equity Forward Agreements: an equity forward contract is an agreement to buy or sell and individual stock, a stock portfolio, or a stock index at an agreed price at some point in the future.

2. Bond Forward Agreements: forward contracts on zero coupon bonds are typically treasury bills contract where the buyer of the contract agrees to buy a treasury bill at a future date and at a price agreed to today. Treasury bills are a discount security that matures at face value. Interest is received implicitly by buying the treasury bills at a discount to face value.

3. Currency Forward Agreements: another active forward market is the currency forward market. Currency forwards involve two parties who agree to exchange currencies at a future date and a specific exchange rate.

4. Commodity Forward Agreements: a forward market where commodities like gold, silver, wheat, livestock are exchanged for a future date and future prices by seller and buyer usually for hedging and arbitrage purpose and at times for speculation.27

27

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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3.2 ADVANTAGES AND DISADVANTAGES OF FORWARD CONTRACTS

There are various advantages and disadvantages of forward contracts and agreements in the contemporary world.

ADVANTAGES
1. Unregulated Market: The primary advantage of forward contract is that they are unregulated over the counter transactions, so the two counterparties can negotiate any terms that they find mutually agreeable. i.e. customize contracts. 2. Flexibility and low cost: Forward are very flexible and normally no commissions are paid on the trade. Forward contract has three major disadvantages. 3. Hedging: (al/at-tahawwut) a risk management technique used to reduce, mitigate and eliminate risk. 4. Speculation: attempts to profit from price movements.15

DISADVANTAGES
1. Liquidity: they are often illiquid. Counterparties to a forward contract usually design them to meet specific needs. The buyer may find it difficult to sell the position to a third party because of its specificity. If no third party emerges the buyer may try to cancel the agreement at a fair price. 2. Credit default risk: they have credit risk. Each party to the agreement must trust that its counterparty will perform in the agreed upon manner. This exposes both contracting parties to the risk that the counterparty might default on its obligation. 3. No Organized Market: they are unregulated no formal body has the responsibility of setting down rules and procedures designed to protect forward market participants. Generally, only contract low protect parties involved in the OTC forward market.15

28

(2010). Derivatives. Chapter 15. CFA Level 1 Online Study Guide. Investopedia.

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3.3 ISLAMIC FORWARD CONTRACT:

God (Allah) has put the instructions and the principle of Sharia to be as a guide for everything in our life for wisdom from him, but if we looked into it deeply we can understand from his wisdom little by looking deeply toward today tools and problems. God has prohibited any transaction that may lead us to Reba but the reason from this prohibition and warning for the people who use Reba is to avoid the crises that will case financial crises, economy crises, social, crises and so on. These are the consequences that will happen in life as a punishment which it's just a part of the punishment that God prepared for the traders in Reba. For this reason, Allah is blaming the people who trade in Reba in helping in destroying the system of life and hurting the shield of the society. 29

29

Saiful Rosly. (2005). Critical Issues on Islamic Banking and Financial Markets. AuthorHouse

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From this point, after knowing the advantage and disadvantage of the forward contract and the reason for prohibiting this kind of tools we reached some solutions:

1. First make sure that there is available money in the account of both parties. 2. Secondly, the traders should have the ability to negotiate directly. 3. Thirdly, both parties must know with whom they are trading with. 4. Fourthly, Must avoid any interest rate in any contract even from the third party (the bank).

5. Fifthly, the underlying assets must be known and the certainty is the major part of the contract. 6. Doing contract that combine Murabha and Tawaruq can act as a forward contract. Doing these steps make us have a forward contract under the shadow of Sharia principles. 7. Doing the other two types of contracts which are Salam and Istisnaa.

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4. FUTURES CONTRACTS
Future contracts are standardized contracts, where there is an agreement between two parties to buy or sell as assets at a certain time in the future for a certain price in a market place. They are traded on an exchange market, and to make this trading possible, the exchange market specifies a certain standardized features of the contract like contract size, the settlement date, and delivery arrangement. Firstly, the two parties of the contract do not necessarily know each other. Also, the exchange provides a system or a clearing mechanism that gives the two parties a guarantee that the contract will be guaranteed. There are many markets which have the future contracts, one of the biggest ones are Chicago Board of Trade (CBOT) which is located in United State of America. Also, there are the Chicago Mercantile Exchange (CME), LIFFE (London), Eurex (Europe), BM&F (San Paulo ,Brazil), and TIFFE (Tokyo).30 Many commodities are a part of future contracts in the modern futures trading, such as wheat, live cattle, sugar, wool, lumber, platinum, aluminum, gold, and tin. Similarly, traders can exchange different types of financial assets, such as stock indices, currencies, and Treasury bonds. To accomplish the full future contract it must have some features. Firstly, there is an exact delivery date which is usually not specified. (Contract is referred to by its delivery month, and the exchange specifies the period during the month when delivery must be made).30 In commodities contract, the delivery period sometimes the while month, and the holder of the short position has the right to choose the time during the delivery period when he or she will make the delivery.
30

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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Moreover, contracts with different delivery months are traded at any one time. So, the commodities have different maturity time, but the buyer trades them at the same time. In case of assets, the exchange market specifies the amount of the assets to be delivered for one contract and the way that future price is to be extracted. On the other hand, in case of commodity, the exchange market specifies the product quality and the delivery location. Like other derivatives types, there are three different types of traders who practice the future contract. These traders are Hedgers, Speculators, and Arbitrageurs.

To trade in an official way, traders must deposit margins. A margin is cash or marketable securities deposited by an investor with his or her broker.31 The balance in the margin account is adjusted to reflect daily settlement. Also, margins minimize the possibility of a loss through a default on a contract. The delivery of the future contract has some rules. Firstly, if a futures contract is not closed out before maturity, it is usually settled by delivering the assets underlying the contract. Also, when there are alternatives about what is delivered, where it is delivered, and when it is delivered, and the party with the short position chooses. Moreover, a few contracts (for example, those on stock indices and Eurodollars) are settled in cash. Maturity is the time period of settlement or expiration of an agreement which describes when the contract must be full field. Settlement price is the price just before the final bell each day.31

31

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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There are some regulations of future contract in order to protect the public interest. Regulators try to prevent uncertain trading practices by either individual on the floor of the exchange or outside groups.

The diagrams on the right shows, how a short and a long futures contract work.

Open Outcry All future trading must be done by open outcry. Open outcry means that bids and offers must be publicly disclosed to all market participants. No side trading is allowed, and in fact, it is a violation of exchange rules that carries stiff penalties. In addition all trades are recorded for all to see.32

Open interest When one party buy and counterparty sell a contract, these are viewed as the two sides of one complete contract thus, every long/short position per constitutes one unit of contract volume.

32

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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The total number of contracts long/short positions pairs (with obligations to deliver is called the open interest. Thus, open interest is the sum of the entire long, or the entire short, positions that are open, but not both.33

Closing out future positions Offsetting transaction: a party can effectively close out a contract position buy entering into a reverse position in another contract with the same underlying asset, settlement date, and contract size as the contract that is being closed out. Delivery of underlying asset: delivery is making (taking) possession of the physical asset underlying the contract according to the terms and conditions specified by the contract. In this case, at the time the contract settles, the long position pays the invoice price to the short position in exchange, the short position delivers the contract size of the underlying asset to the long position at the place, time, and in the form specified in the contract. Cash settlement: some contract are settled for cash on the day the contract expires, the loss realized by one party to the contract is paid, in cash, to the other party to the contract becoming that partys realized gain. Most financial derivatives use cash settlements. 34 Calculating loss and gain contract Gain on long position = loss on short position = [Number of Contracts x Contract Size x (FT FO) ] FT = is the contract price when the trade is initiated. FO = is the contract price at the time the position is closed.34
33

34

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing. John Hull. (2009). Options Futures and other derivatives. Fifth Edition.

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Role of the Clearing House The clearing house act as the counterparty for each side of the trade, this makes it possible for one party to close out its position in a contract simply by selling its long position or covering its short position at any time, without actually locating and negotiating with some specific counterparty. This provides liquidity to the market, thereby, eliminating one of the disadvantages of the forward contract market. In addition, the clearing house enforces margin requirements to ensure that market participants honor their commitments.35

Margin Initial Margin: is an amount of money that traders must deposit with their brokers before executing a future transaction. Maintenance margin: is the minimum level below which the margin account is not permitted to fall without a margin call. If the value of the margin account falls below the maintenance margin, the trader will receive a margin call (a notice from the clearing house) to deposit additional funds or securities in his or her margin account. Daily settlements: the clearing house requires daily settlements of all gains and losses. Every day, any gain or lose incurred by the holders of the long and short positions resulting from changes in the market price of the futures contract are added to the subtracted from each traders margin account. This process is called marking to market.35

35

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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4.1 TYPES OF FUTURE CONTRACTS

1. Commodities: commodities make up the raw material used in production of this group. There are 3 basic categories of commodity contracts used: 1) Agricultural products: such as animals, fruits, grain and fiber products. 2) Metals: such as gold, silver and copper. 3) Energy: such as oil, natural gas and gasoline.

2. Interest Rate Futures: there are two types of interest rate futures. 1) Short term interest rate futures contracts are traded for US treasury bills and Euro dollar accounts. 2) Intermediate and long term interest rate futures, US treasury notes and bonds make up the underlying assets of intermediate and long term interest rate future contracts.

3. Stock Index Futures: stock market futures S&P 500 index value line index, major market index, NIKKII index and so forth (are very popular investment vehicles, index futures contracts are quoted based on the underlying index, such as the S&P 500 index, that is continually reported throughout the day.

4. Currency Future: currency future is also popular, although currency forward predominates. The underlying assets are units of the foreign currency. These contracts call for physical delivery of a stated amount of currency at an exchange rate specified in the contract.36
36

(2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing.

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4.2 ADVANTAGES AND DISADVANTAGES OF FUTURE CONTRACTS

There are various advantages and disadvantages of future contracts and agreements in the contemporary world.

ADVANTAGES
1. Organized Market: The future market provide a mechanism that is sought to overcome difficulties by making it possible for buyers and sellers to enter the market for price discovery, high liquidity and standardized contracts. 2. Credit Default Risk is less: Due to the clearinghouse the act of failing by one party to pay its financial obligation is minimized or almost reduced to null. 3. Margin Accounts: Deposits in sellers and buyers accounts are marked to market daily with the price movements. 4. Hedging: (al/at-tahawwut) as a function of the futures acquires much significant in the fast moving goods and capital and volatile exchange.
23

DISADVANTAGES
1. Obligation to complete the contract: The long and short position holders have the obligation but not the option to carry out a transaction. 2. No customization of contracts: The contracts cannot be tailor-made, like in forward contracts (which are mutual agreements between sellers and buyers) after certain exchange of promises or contracts.

3. Complex options: some options strategies are dangerous for new inexperienced traders 4. Excessive Trading 5. Speculation. 37

37

(2010). Derivatives. Chapter 15. CFA Level 1 Online Study Guide. Investopedia.

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4.3 CONTEMPORARY FUTURES IN THE SCOPE OF ISLAMIC LAW (SHARIA):

According to the Hadith SELL NOT WHAT IS NOT WITH YOU, reviewers who have disputed the acceptability of futures in Islamic law have highlighted the following five points in their evaluation:

1) Futures proceed over goods that are non-existent at the time of contract agreement. Hence, a futures contract is mostly a paper transaction and not a sale of a genuine good. 2) Futures consist of sales in which the seller does not own the item he sells. 3) Futures involve excessive speculation that margins on gambling. 4) In the contemporary futures contracts there is no requirement of qabd (taking possession of the good) prior to resale. In other words, it is an optional thing and not a necessary requirement. 5) Delay of both sides of the bargain to a future date turns futures into the sale of one debt for another.38 Although the Sharia principle of acceptability (ibha) that renders all commercial transactions (muamalat) permissible in the absence of a clear prohibition, one is confronted with the decision of some Fiqh Academies and scholars who have declared futures trading forbidden. This body of opinion is founded mainly in the premise that futures trading do not fulfill the requirements of the conventional law of sale as specific in the fiqh al-mucmalt. The fact that futures represent a new market phenomenon is almost totally ignored.38

38

Sherin Kunhibava. (2010). Derivatives in Islamic Finance. International Sharia Research Academy for Islamic Finance. Research Paper

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The basic justification of taking possession of the subject matter of sale is clearly to prevent gharar on account of uncertainly over the seller's ability to deliver. If gharar can be effectively removed, then it follows that the requirement of qabd may be relaxed or totally lost. Some scholars said that the future due to their non-existence at the time of contract. This is because delay of the transfer of ownership in proprietary contracts (cuqd al tamlk), such as sale, to a future date is a form of gambling, and therefore prohibited. Sale must, in other words, transfer ownership immediately.39

The Makkah-based Fiqh Academy has taken an unsure view of futures. While the Academy acknowledged the benefits of futures to farmers and commodity traders, this was not reflected in its final judgment on the subject. The Academy also acknowledged that futures trading had developed into a variety of different transactions, and need to be evaluated on that basis, but this view was also not reflected in its final resolution, which is prohibitive on futures as a whole and does not attempt to address individual issues. Futures are forbidden, as they involve the sale of assets the seller does not own nor possess nor do they exist at the time of contract. The parties to a futures contract were also not interested in making or taking delivery and that brings futures closer to gambling rather than trading. 40

39

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Sherin Kunhibava. (2010).Derivatives in Islamic Finance. International Sharia Research Academy for Islamic Finance. Research Paper Mohammad Kamali. (ND). Commodity Futures: An Islamic Legal Analysis. International Islamic University Malaysia.

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4.4

ISLAMIC FUTURE CONTRACTS:

As a result of these opinions in prohibiting the future contracts in the view of Islamic Low, and understanding the advantages and disadvantages of future contracts; here are the solutions that might solve the issue:

1- Open a market under the control of committee which consist of finance and Islamic scholars who will be responsible for any contract done on that market. 2- The market will open for one day per a week and that is for many reasons. Firstly, in order to grantee liquidity for one week better than unguaranteed liquidity for every day. Secondly, both parties will be able to trade after studying the contract affect and they can make the best decision for their sides. Thirdly, they will have enough time to repair the contract which must follow the Islamic law. Fourthly, if the contract were prohibited in Islam, both parties have enough time to revise it and practice it on the week after, so they still have the chance to do it. Fifthly, the buyer and the seller can find within the week the best offer for them, and they can decide the condition of the contract. Finally, companies can repair themselves either to buy or to sell within a week. 3- The market will have some rules in order to practice any type of contracts. Firstly, the contract must follow the Islamic law. Secondly, commission must pay to the market in order to make any contract. This commission considers being the profit of market resulting of their controlling and managing the market. Thirdly, contract must submit two days before in order to check the validity of contract within Islamic law. Fourthly, traders reprehensive must have authorization letter from the company in order to have the contract. Fifthly, any contracts must apply on the commodities which are specified and

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halal in the Islamic law. Finally, contracts can be canceled if and only if reach the unavailability in the contracts regulation. 4- There are two alternative contracts allowed for the Islamic future market which is Istisna (definition). We can also use the contract Al-Salam in this type of contract. 5- Each week the market will check all the contracts in case of payment, delivery, ownership, and all the rules of Istisna or Al-Salam. 6- In the Islamic futures market there will be an automatic mechanism that sought to overcome all the problems of conventional futures by making it possible for sellers and buyers to enter the market whenever they needed to at comparatively lower costs for purchasing or selling a contract. One of the most important features in Islamic futures will be that it will allow new possibilities for risk management, efficient and effective investment planning and also new ways to market these financially engineered products. 41
42

41

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Sherin Kunhibava. (2010).Derivatives in Islamic Finance. International Sharia Research Academy for Islamic Finance. Research Paper Mohammad Kamali. (ND). Commodity Futures: An Islamic Legal Analysis. International Islamic University Malaysia.

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5. Options Contracts
An option is a derivative financial instrument that establishes a contract between two parties concerning the right - and not the obligation - of the buying (call options) or selling (put options) of an asset at a reference price during a specified time frame.43 in this period, the party which acquires the option will possess the right - but not the obligation - to be involved in activities affecting the underlying asset. On the other hand, the writer of the option gains from the fluctuating value of the underlying asset which is usually a bond, or a stock, or a currency or a futures contract. Furthermore, the writer of the option also gains from the premium paid by the acquirer, which is based upon the maturity date of the given option, the maturity of options is usually after a year of acquiring it, however, it is not always the case.

An option which conveys the right to buy something is called a call; and an option which conveys the right to sell something is called a put.44 Furthermore, every option has a given strike or exercise price, at which the trader could use the respective acquired option. Using the already acquired option is referred as exercising it. It is also important to mention that -usuallymost options have a given expiration date, and if the acquired option is not exercised before the predetermined expiration date it will be considered worthless and void.

The writer of the option receives a payment from the buyer which is referred to as a premium. Furthermore, and if the option is exercised the writer should be able to either deliver the underlying asset, or the equivalent of the underlying asset in cash.

43 44

(2011). Options Basics: What Are Options. Investopedia. (ND). Beginners Guide to Options. Traders EdgeIndia.

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An option can be traded on over the counter markets it is also traded -sometimes- on anonymous options exchanges.

5.1
1.

THE BASIC TRADES OF STOCK OPTIONS

Long call

Buying a call is one of the many basic trading strategies. It is a contract in which a trader believes that the price of an underlying asset will increase, and hence will buy the right to purchase the given asset, rather than the asset itself. The long call acquirer will have the right, and not the obligation to buy the underlying asset up to the date of expiry. Furthermore, if the price of the asset at the expiration date is above the exercise price by more than the premium paid, the acquirer will register profit. And if the asset price at the expiration date is lower than the exercise price, the acquirer will let the call contract expire with a loss, and hence, will only lose the amount paid as a premium. Traders might favor buying the options over buying the shares; this is so because they will be able to control a larger number of shares with the same amount of money which would be needed to buy the actual shares.

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Long put

A Long put, which is buying a put option, is one in which a trader believes that the price of an underlying asset will decrease, and hence will buy the right to sell the given asset, rather than the asset itself. The long put acquirer will have the right, and not the obligation to buy the underlying asset up to the date of expiry. Furthermore, if the price of the asset at the expiration date is bellow the exercise price by more than the premium paid, the acquirer will register profit. And if the asset price at the expiration date is higher than the exercise price, the acquirer will let the call contract expire with a loss, and hence, will only lose the amount paid as a premium. Traders -in this case as well- might favor buying the options over buying the shares, this is so because they will be able to control a larger number of share with the same amount of money which would be needed to buy the actual shares.

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2.

Short call

Selling a call is another option basic trading strategy. It is a contract in which a trader believes that the price of an underlying asset will decrease, and hence will sell the right to buy the given asset, rather than the asset itself. The short call acquirer will have the right, and not the obligation to sell the right to buy the underlying asset up to the date of expiry. Furthermore, if the price of the asset at the expiration date is below the exercise price by more than the premium paid, the acquirer will register profit. And if the asset price at the expiration date is higher than the exercise price, the trader might register unlimited losses.

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3.

Short put

Selling a put is another option basic trading strategy. It is a contract in which a trader believes that the price of an underlying asset will increase, and hence will sell the right to sell the given asset, rather than the asset itself. The short put acquirer will have the right, and not the obligation to sell the right to sell the underlying asset up to the date of expiry. Furthermore, If the price of the asset at the expiration date is above the exercise price by more than the premium paid, the acquirer will register profit. And if the asset price at the expiration date is lower than the exercise price, the trader might register unlimited losses.

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5.2 ADVANTAGES AND DISADVANTAGES OF OPTIONS CONTRACTS

There are various advantages and disadvantages of options contracts and agreements in the contemporary world.

ADVANTAGES

DISADVANTAGES

Advantages of Options Trading 1- Flexibility. Options can be used in a wide variety of strategies, from conservative to high-risk, and can be tailored to more expectations than simply "the stock will go up" or "the stock will go down." 2- Leverage. An investor can gain leverage in a stock without committing to a trade. 3-Limited Risk. Risk is limited to the option premium (except when writing options for a security that is not already owned). 4-Hedging. Options allow investors to protect their positions against price fluctuations when it is not desirable to alter the underlying position.

Disadvantages of Options Trading 1-Costs. The costs of trading options (including both commissions and the bid/ask spread) is significantly higher on a percentage basis than trading the underlying stock, and these costs can drastically eat into any profits. 2-Liquidity. With the vast array of different strike prices available, some will suffer from very low liquidity making trading difficult. 3-Complexity. Options are very complex and require a great deal of observation and maintenance. 4-Time decay. The time-sensitive nature of options leads to the result that most options expire worthless. This only applies to those traders that purchase options those selling collect the premium but with: 5-Unlimited Risk. Some option positions, such as writing uncovered options, are accompanied by unlimited risk.

45

(2010). Derivatives. Chapter 15. CFA Level 1 Online Study Guide. Investopedia.

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5.3 OPTIONS IN THE SCOPE OF SHARIAH

When options are viewed solely as a promise to buy or sell an asset at a predetermined price within a stipulated period, Sharia scholars find nothing objectionable with options. However, it is in the trading of these promises and the charging of premiums that objections are raised by sharia scholars. These objections are generally based upon two main arguments; one arguments states that options involve Ghirar (un-necessary risk/uncertainty), and another states that options involve Maisir (unearned gains).

The contemporary options, used by the world's non-Islamic economies, are not allowed in Islamic finance given that the trading and charging of a premium -in an option- for the promise is not acceptable by Islamic Sharia, This ban is not very beneficial to Islamic economies given that hedging, arbitraging -using options - are undoubtedly useful. Hedging -aside from enabling businesses to plan better- reduces fluctuations of product prices, which can help reduce costs and thereby provide a tangible benefit to society. Consumers would benefit from allowing options trade- since producers need charge lower risk premiums. Also, Arbitrageurs by means of their activities ensure that prices in different markets do not diverge from each other. Arbitrage activity enhances the price discovery process, for example, arbitrage between markets in different countries internationalizes product prices. This forces less efficient producers to enhance productivity in order to remain in business. Furthermore, it should be noted that speculating activities in trading options are -on the contrary to previously mentioned activitiesmore harmful than they are beneficial.

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As we have previously mentioned, Islamic scholars have two main objections regarding the use of options. These objections mainly revolve around Ghirar and Maisir. The first objection states that Options trade involves Ghirar because there is uncertainty and a potential for default in such financial instruments. However, this objection might have ignored the fact that exchanges place margin requirements on sellers of options precisely to prevent default. It is also important to note that buyers of options would by definition not default since their maximum possible losses is the premium (long call and long put), all of which is fully paid for at the time of purchase. The second objection states that Options trade involves Maisir (unearned gains). However, this Objection ignores the fact that both the buyer and the seller take on risk and that the buyer also has at stake the premiums he has paid. Furthermore, the change in an option's value arises from changes in underlying asset value and not by chance or gambling. If such gains are unearned then that implies that all capital gains income could also be considered unearned.

Aside from individual interpretations, the differing opinion among the different Islamic mathematicians complicates the situation further. Thus, an options contract may be found objectionable for exactly opposite reasons. While some Islamic mathematicians in Hanbalis school of thought have been broader in their acceptance, the Shafi and Hanafis have been less so. The Hanbalis for example are somewhat liberal when it comes to Option of stipulation (Khiyar-al-Shart). The Hanbalis hold that stipulations that remove a hardship, fulfills a legitimate need, provide a benefit or convenience, or facilitate the smooth flow of commercial transactions are generally valid as a matter of principle.

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5.4

ISLAMIC OPTIONS DERIVATIVES

The solution for options might be found within the Islamic financial concept of Istijrar

and Wa'ad. Istijrar is defined as an agreement whereby a buyer purchases something -in a specified period of time- in which there is no offer or acceptance or bargain, and there is only one master agreement where all terms and conditions are finalized. Furthermore, Istijrar Contracts involve two parties: the buyer which is usually a company seeking financing to purchase and acquire an underlying asset, and a financial institution. The financial institution buys the commodity or the underlying asset at the market price and resells it to the company at a price to be paid at a specified date in the future. The actual price to be paid -at the previously specified date- depends on the underlying asset's price movement from the day of the contract initiation to the day of maturity.

Wa'ad, which is a promise or undetaking, can be introduced and used as a tool to create Islamic Derivatives. A Wa'ad (promise) is usually unbinding and has no value, however; in certain circumstances a Wa'ad (promise) will be binding and of value.

The following are requirements for a Wa'ad to be binding:

1. It must be unilateral 2. It must have the caused the promise to have incurred some costs and/or liabilities. 3. If it is a Wa'ad to purchase something -such as a commodity- , then the actual sale

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must take place at the previously appointed time by the exchange of offer and acceptance. The Wa'ad (promise) itself should not be taken as the concluded sale. 4. If the promisee fails to fulfill the Wa'ad (promise), the court may force them to either purchase the commodity or pay actual damages to the seller. The actual damages incurred by the seller will include the actual losses suffered by the Wa'ad promise; however, it will not include the opportunity lost.

If such conditions were imposed and attached to a given Wa'ad, it would be -probablypossible to create a groundbreaking Islamic financial product infused with characteristics of contemporary options. 46 47

46

47

Sherin Kunhibava. (2010).Derivatives in Islamic Finance. International Sharia Research Academy for Islamic Finance. Research Paper Mohammad Kamali. (ND). Commodity Futures: An Islamic Legal Analysis. International Islamic University Malaysia.

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6. RECOMMENDATIONS FOR ISLAMIC DERIVATIVES IN SAUDI ARABIA

There must be Sharia Finance Committee, which should have a role in the Saudi Community to put the right rules and regulations for trading in Islamic banking and they must form consensus with regards to how derivatives should be traded. This committee must be well chosen, have a PHDs in Islamic Finance. The members must be chosen by the trust of H.E. King Abdullah. Other organizations and banks in the private and government sector must go back to this committee in every issue they face. Also, these organizations do not have the right to hire a committee that can give the approval or solutions to any issues in Islamic banking, because they can be blamed to take advantage from the opportunity.

The Saudi Financial economy is growing at a steady rate and there is a need for a focus on the stable growth. It is starting to attract more and more of the international investors with it stable growth and the huge financials steps that are taken. Rather than focusing on neighbors in the region, where the growth is very fast, investors see it very risky to invest as we found from our interviews. This kind of a problem became a reality in Dubai economic crises. On the other hand, Saudi Arabia is drawing a long term plan that will be ready after 20 to 25 years. Furthermore, looking to today King Abdullah Financial City, Riyadh Financial City on Qassim Road and the new rules in Tadawul Stock Index shows the focus of the King and the government for the growth of the financial sector to the economy. Our recommendation to the Saudi Government is to avoid big steps and to make stricter step by step and stable growth for the sector in compliance with the Sharia rules and regulations.

Moreover, so that Saudi Arabia can avoid competition with neighboring countries, to focus on new features and new tools for new potential Islamic investors. There is also a need for

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motivation in the Islamic financial society to search for how to be unique and to invent new tools, instrument and features that will add value to our financial center. For Example, adding derivatives to Islamic finance to attract new investors and specially Muslims who are avoiding conversion investments.

There is also a need for a futures market which has standardized contracts, with the amount quantity of good specified, color specified, quality specified and with regards to the goods complied with the Islamic rules and regulation. This will attract more and more investor not only from Saudi Arabia but also all around the world to invest in the potential Saudi Futures Market Exchange.

We know that most participants in the future market are hedgers, who always look for the zero risk investment that does not exist in the real life. Furthermore, the need for the Islamic investor is very important which can make the Saudi Arabia the world leader in Islamic Finance and the attract hedgers. Starting with certain Islamic derivatives with consensus as starting point can be a good set up, where the Saudi government can be the first country that provides tools for all interested investors in Islamic derivatives in the region.

Derivatives are a very risky financial instrument in general and it is said to be the main reason for having the financial meltdown in the United States and the rest of the other world. However, in implementing derivatives in Islamic finance can reduce the risk to a large extent, yet it still needs to be coordinated by Islamic committee in Saudi Arabia along with recommendations from Islamic banks. In addition, there must be a maximum limit between individual traders and a limit for the daily transaction to achieve the quartile target or limit in the year that is decided by the financial analyst and the policies defined by the potential organized exchanges in Saudi Arabia.

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Given the advantages incurred by hedging and arbitraging, and the benefits which consumers and producers will obtain from such activities; we believe that Islamic finance scholars and scientist should approach options on the basis of "Maslaha Morsala"; this is so, because there are no clear texts which forbid or allow such financial tools. This proposed Islamic option solutions will not be similar to any contemporary option, in that it will not allow speculation "Ghirar", and there will be a physically existing underlying asset in order for these activities to not be considered "Maisir". Any Islamic option should have its price directly connected to the underlying asset, and some scholars say that it should have a maturity date of three days or less based on the concept of "options of stipulation".

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7.

CONCLUSION

The overall image of Ulema, for conventional derivative instruments appears to be in doubt and suspicion. That these instruments and contracts could easily be used for speculation as it appears to be the key reason for objection. That derivatives form the basis of risk-management appears to have been lost. The problem is that the analysis has always been from a purely juridical viewpoint. And like most juristic analysis and evaluation, have relied on precedence? However, there is no precedence or any equivalence for the kind of risk-management problems faced today. When extrapolating/inferring: the template may be wrong. 48

The object of juridical evaluation appears to be a micro examination of each and every feature of a derivative instrument to see if it passes a subjective rather than objective religious filter. Apart from individual interpretation, the differing opinion among mazhabs / imams (sects or schools in Islamic religion) further complicates the situation further. Thus, for example an options contract may be found objectionable for exactly opposite reasons. While some mazhabs like the Hanbalis (primarily Saudi Arabia) have been broader in their acceptance, the Shafi and Hanafis have been less so. The Hanbalis in Saudi Arabia for example are somewhat liberal when it comes to Option of stipulation (Khiyar-al-Shart). 49

The Hanbalis in Saudi Arabia, also hold that stipulations that remove a hardship, fulfills a legitimate need, provide a benefit or convenience, or facilitate the smooth flow of commercial Obiyathulla. (ND). Derivatives in Islamic Finance an overview. International Islamic University, Malaysia. Power point Presentation. 49 Obiyathulla. (ND). Derivatives in Islamic Finance an overview. International Islamic University, Malaysia. Power point Presentation.
48

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transactions are generally valid as a matter of principle. Clear understanding is need for a more coordinated evaluation; need based rather than purely juristic/precedent driven. The solutions given in this research paper are just a probable solutions to be further researched in a more scientific and Islamic manner at the same time for potential Islamic financial engineering.

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8.

REFERENCES:

1. (2010). Derivatives (Finance). World wealth vs. Derivatives. Wikipedia. Retrieved on 2th January, 2011 from
[Link]

2. (2010). Derivatives and Alternative Investments. Derivatives Market and Instrument. CFA program curriculum. Volume 6. Level 1 2010. Pearson Custom Publishing. Book 3. (2010). Derivatives. Chapter 15. CFA Level 1 Online Study Guide. Investopedia. Retrieved on 21st December, 2011 from [Link]

4. (2010). ISDA. International SWAPs and Derivatives Association Inc. Retrieved on 10th January, 2011 from [Link] 5. (2011). Forward Contract. The Free Encyclopedia. Wikipedia. Retrieved on 10th January, 2011 from [Link] 6. (2011). Forward Contract. Wiki Invest. Retrieved on 8th January, 2011 from
[Link]

7. (2011). Options Basics: What Are Options. Investopedia. Retrieved on 10th January, 2011 from [Link] 8. (2011). CME Group. Retrieved on 12th December, 2011 from [Link]

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9. (ND). Beginners Guide to Options. Traders EdgeIndia. Retrieved on 10th January, 2011 from [Link] 10. (ND). Bay Salam. Islamic Finance. Retrieved on 10th January, 2011 from
[Link]

11. (ND). Istijrar. Finance Al Islam. Pakistan. Retrieved on 19th December, 2011 from
[Link]

12. (ND). Salam. Financial Islam. All About Islamic Banking and Insurance. Retrieved on 10th January, 2011 from [Link] 13. Askari, Iqbal, Mirakhor. (2009). New Issues in Islamic Finance and Economics. Progress and challenges. Islamic Finance. Wiley Finance. Book 14. Banking Info. (2009). Your guide to basic principles of Islamic Banking. What is Islamic Banking?. Bank Negara Malaysia. Retrieved on 21th December, 2011 from
[Link]

15. Dennis Estrada. (ND). What is Murabaha Financing? Ezine Articles. Retrieved on 14th December, 2011 from [Link] 16. Ijlal Alvi. (ND). Challenges of Islamic Financial Market Development. International Islamic Financial Market. The world Islamic Banking. Research Paper. 17. John Hull. (2009). Options Futures and other derivatives. Fifth Edition. Book. 18. Johnson. (1999). Derivatives: Managers Guide to the worlds most powerful financial instruments. Retrieved on 12th December, 2011 from [Link] erivatives&source=bl&ots=3HKvu1ZY8t&sig=hE74cQObNq2566a340xyi_lcBoA&hl=e n&ei=YAgnTdKrN4qYnwfT2IGNAQ&sa=X&oi=book_result&ct=result&resnum=7&v ed=0CEEQ6AEwBjgK&safe=active#v=onepage&q&f=false

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19. Kabir and K. Lewis. (2007). Handbook of Islamic Finance. Edward Elgar Publishing Limited. United Kingdom Retrieved on 10th January, 2011 from
[Link] ource=bl&ots=72mO3mLYrz&sig=XTC4ehmSVDtVyMOHS5eMtneeSIU&hl=en&ei=O4QxTcWnMs 6g4Qa_3tS2Cg&sa=X&oi=book_result&ct=result&resnum=1&ved=0CBIQ6AEwAA#v=onepage&q =istijrar%20parallel&f=false

20. Mohammad Kamali. (ND). Commodity Futures: An Islamic Legal Analysis. International Islamic University Malaysia. 21. Myra Valladares. (2009). Overview of Derivatives. MRV Associate. Chicago Board of Trade and Chicago Mercantile exchange (CME Group). Retrieved on 20th November, 2011 from [Link]

22. Obiyathulla. (ND). Derivatives in Islamic Finance an overview. International Islamic University, Malaysia. Power point Presentation. 23. Qazi Irfan. (2008). Murabaha Financing vs. Lending on Interest. A thin line in making a big difference in understanding of Riba Retrieved on 1st January, 2011 from
[Link]

24. Saiful Rosly. (2005). Critical Issues on Islamic Banking and Financial Markets. AuthorHouse. Book 25. Sherin Kunhibava. (2010). Derivatives in Islamic Finance. International Sharia Research Academy for Islamic Finance. Research Paper 26. Siddiqui. (2007). Economics of Tawarruq. How is it mufasid overwhelm Masaliah. Retrieved on 5th January, 2011 from
[Link]

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27. Siti Razali. (ND). The concept of Waad in Islamic Financial Contract. Dept. of Business Administration. Kulliyah. Retrieved on 10th January, 2011 from
[Link]

28. Wikipedia. (2007). World Wealth vs World Derivatives. Retrieved on 12th November, [Link]

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9.

INDEX: GLOSSARY OF TERMS

1. Al-Muamalat (Islamic rules on transactions): the transactions that is used in the Islamic finance and they represented in fiqh al muamalat which is presents a framework for conduct in the civil arena. It deals in part with economic functions in an Islamic society but not comprehensively with factors impacting upon economic behavior since it is concerned solely with legal relationships between members of the society. Under muamalat, any action that is not specifically or generally described as prohibited or haram automatically becomes permissible or halal. 2. Arbitragers: A type of investor who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capturing risk-free profits.

3. BM&F (San Paulo, Brazil): The BM&FBOVESPA (; in full, Bolsa de Valores, Mercadorias & Futuros de So Paulo) is a So Paulo-based stock and futures exchange. It is the fourth largest exchange in the Americas in terms of market capitalization, behind the New York Stock Exchange, NASDAQ, and Toronto Stock Exchange. 4. Bond Forward Agreements: forward contracts on zero coupon bonds are typically treasury bills contract where the buyer of the contract agrees to buy a treasury bill at a future date and at a price agreed to today.

5. Call options: financial contract between two parties, the buyer and the seller of this type of option. It is the option to buy shares of stock at a specified time in the future. Often it is simply labeled a "call." 6. Cash settlement: some contract are settled for cash on the day the contract expires, the loss realized by one party to the contract is paid, in cash, to the other party to the contract becoming that partys realized gain. Most financial derivatives use cash settlements. 7. Chicago Board of Trade (CBOT): The Chicago Board of Trade (CBOT), established in 1848, is the world's oldest futures and options exchange. More than 50 different options and futures contracts are traded by over 3,600 CBOT members through open outcry and e Trading. 8. Clearing house: act as the counterparty for each side of the trade. Also, enforces margin requirements to ensure that market participants honor their commitments. 9. Commodity Forward Agreements: a forward market where commodities like gold, silver, wheat, livestock are exchanged for a future date and future prices by seller and buyer usually for hedging and arbitrage purpose and at times for speculation.

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10. Contract size: The actual amount of a commodity represented in a contract. 11. Daily settlements: the clearing house requires daily settlements of all gains and losses. 12. Default risk: The possibility that a bond issuer will default, by failing to repay principal and interest in a timely manner. Bonds issued by the federal government, for the most part, are immune from default (if the government needs money it can just print more). Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. Municipalities occasionally default as well, although it is much less common. Also called credit risk. 13. Delivery of underlying asset: delivery is making (taking) possession of the physical asset underlying the contract according to the terms and conditions specified by the contract. 14. Delivery price: the price that is agreed on today in case of buying or selling contracts. 15. Derivatives: Is sort of a hypothetical and synthetic financial instrument where the value is based on some other asset classes such as index, commodity, bond and other similar assets. 16. Equity Forward Agreements: an equity forward contract is an agreement to buy or sell and individual stock, a stock portfolio, or a stock index at an agreed price at some point in the future. 17. Eurex (Europe): Eurex is the world's largest futures and options exchange, providing European benchmark derivatives featuring open and low-cost electronic access globally. 18. Exchange (LIFFE ,pronounced 'life'): is a futures exchange based in London. LIFFE is now part of NYSE Euro next following its takeover by Euro next in January 2002 and Euro nexts merger with New York Stock Exchange in April 2007. 19. Exchange market: A physical or virtual facility where the exchange of goods, services , information, and payment is conducted (For purposes of this project ,distribution infrastructures are considered virtual exchange markets. 20. Exchange traded: derivatives trades on an organized and regulated exchange (e.g. a futures exchange or an options exchange) 21. Face value: The nominal value or dollar value of a security stated by the issuer. For stocks, it is the original cost of the stock shown on the certificate. For bonds, it is the amount paid to the holder at maturity (generally $1,000). Also known as "par value" or simply "par". 22. Forward contract: It is a non standardized contract, which occurs between two parties (buyer and seller) on a trading (underlying) asset, at a known forward time and at a price that is agreed on it today.

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23. Fluctuations: move or sway in a rising and falling or wavelike pattern; "the line on the monitor vacillated. 24. Future contracts: are standardized contracts, where there is an agreement between two parties to buy or sell as assets at a certain time in the future for a certain price in a market place. 25. Gharar (unnecessary): It has been taken to mean, unnecessary risk, deception or intentionally induced uncertainty. In the context of financial transactions, gharar could be thought of as looseness of the underlying contract such that one or both parties are uncertain about possible outcomes.

26. Halal (acceptable): are the things that are accepted to practice, have, eat, or apply in Muslims life according to the Islamic Law. 27. Hanafis: The Hanafi (Arabic ) school is one of the four Madhhab (schools of law) in jurisprudence (Fiqh) within Sunni Islam. (The other three schools of thought are Shafi'i, Maliki, and Hanbal. 28. Hanbilies: Hanbali ) (is one of the four schools (Madh'habs (rites) of Fiqh or religious law within Sunni Islam (the other three being Hanafi, Maliki and Shafi`i). The jurisprudence school was started by the students of Imam Ahmad bin Hanbal (d. 855... .) 29. Haram (Prohibited): The things that are prohibited in Islam according to the source of Islamic laws. 30. Hedgers: are the people who making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security. 31. Hibah (Gift): This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah usually arises in practice when Islamic banks voluntarily pay their customers a 'gift' on savings account balances, representing a portion of the profit made by using those savings account balances in other activities. 32. Ijarah (Hire purchase): means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipments such as plant, office automation, motor vehicle for a fixed period and price. 33. Initial Margin: is an amount of money that traders must deposit with their brokers before executing a future transaction.

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34. Islamic finance: is a way by which financial and business transactions are carried out with reference to the principals of Islamic Law Sharia. 35. Istijrar: They involve two parties: the buyer, which is usually a company seeking financing to purchase an underlying asset, and a financial institution. The financial institution buys the commodity at the existing price and resells it to the company at a price to be paid at a specified date in the future. 36. Istisna: is sail contract between the ultimate buyer (Al Mostasni) and the seller (Sani), whereby the seller based on an order from the ultimate buyer undertakes to have the manufactured or otherwise acquired product (Al Masnoo). 37. Jahl (ignorance): refers to ignorance. From a financial transaction viewpoint, it would be unacceptable if one party to the transaction gains because of the other partys ignorance. 38. Khiyar-al-Shart: A right, stipulated by one or both of the parties to a contract, to cancel the contract for any reason for a fixed period of time. 39. Leverage: An investor can gain leverage in a stock without committing to a trade. 40. LIFFE (London): The London International Financial Futures and Options. 41. Liquidity: The degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Liquidity is characterized by a high level of trading activity. Or is the ability to convert an asset to cash quickly. Also known as "marketability". 42. Long position: is the buy position where it is assumed that a contract will be purchased for the value of certain assets for a certain price at a forward date. 43. Maintenance margin: is the minimum level below which the margin account is not permitted to fall without a margin call. If the value of the margin account falls below the maintains margin, the trader will receive a margin call (a notice from the clearing house) to deposit additional funds or securities in his or her margin account. 44. Margin: is cash or marketable securities deposited by an investor with his or her broker. 45. Maturity: is the time period of settlement or expiration of an agreement which describes when the contract must be full field. Settlement price is the price just before the final bell each day. 46. Maysir (gambling): a financial instrument viewpoint would be one where the outcome is purely dependent on chance alone as in gambling. 47. Mudharabah (Profit Sharing): is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from

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the first partner who is called "rabb-ul-mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib" 48. Murabaha (Cost plus): Murabaha is the sale of commodity at the price that seller has purchased it, with the addition of stated profit known to both the seller and the buyer. It is the cost-plus-profit sale in which the seller expressly discloses the profit. It is based on trust (Amanah). 49. Musharakah (Joint venture): is an agreement between two or more partners, whereby each partner provides funds to be used in a venture. Profits made are shared between the partners according to the invested capital. In case of loss, each partner loses capital in the same ratio. If the Bank provides capital, the same conditions apply. 50. Offsetting transaction: a party can effectively close out a contract position buy entering into a reverse position in another contract with the same underlying asset, settlement date, and contract size as the contract that is being closed out. 51. OIC fiqh: organization of Islamic council. 52. Open interest: When one party buy and counterparty sell a contract, these are viewed as the two sides of one complete contract thus, every long/short position per constitutes one unit of contract volume. 53. Open outcry: means that bids and offers must be publicly disclosed to all market participants. 54. Option: is a derivative financial instrument that establishes a contract between two parties concerning the right - and not the obligation - of the buying (call options) or selling (put options) of an asset at a reference price during a specified time frame. 55. Ordinary Istina: this is the common type of Istina whereby an agreement between the buyer and manufacturer is concluded based on agreed specification and time of delivery in the future. 56. Over the counter (OTC): meaning the trading is done through a network that is linked with the dealer markets. 57. Parallel Istisna: is a contract of two independent contract agreements but inter-related. 58. Pay off: in such contract is known as sub zero game in which either the buyer or the seller is gaining or loosing. 59. Premiums: the amount that something in scarce supply is valued above its nominal value. Or is payment for insurance.

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60. Profit margin: A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings. 61. Put options: is a financial contract between two parties, the writer (seller) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the underlying instrument at an agreed-upon price (the strike price. 62. Qard (Interest-free loan): This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor 63. Quran: the sacred writings of Islam revealed by Allah to the prophet Muhammad during his life at Mecca and Medina. 64. Riba (interest): which includes the payment and receipt of interest as understood in todays financial markets 65. Salam or (Salaf): defined as the sale or purchase of a deferred commodity in exchange for price paid on the spot. In Salam contract, the price is paid in advanced while the commodity is deferred in future date. 66. Scarce resources: A resource with an available quantity less than its desired use. Scarce resources are also called factors of production. 67. Settlement date: Settlement Date is a securities industry term describing the date on which a trade (bonds, equities, foreign exchange, commodities etc) s. That is, the actual day on which transfer of cash or assets is completed. 68. Shafi: The Shfi madhhab ) (is one of the four schools of fiqh, or religious law, within Sunni Islam. The Shfi school of fiqh is named after Imm ash-Shfi. The other three schools of law are Hanafi, Maliki and Hanbali. 69. Sharia Laws: the Muslims law, the custom-based body of law based on the Koran and the Sunah of the prophet Mohammed and the scholars of Islam. 70. Sharia scholars (ijma): the scholar in Islam who responsible for judgment regarding to any issue based on the Islamic Law. 71. Short position: the seller is assuming to sell a certain assets for a certain price at forward date. 72. Speculators: A person who trades derivatives, commodities, bonds, equities or currencies with a higher-than-average risk in return for a higher-than-average. Profit

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73. potential: Speculators take large risks, especially with respect to anticipating future price movements, in the hope of making quick, large gains. 74. Sukuk (Islamic Bonds): is the Arabic name for financial certificates that are the Islamic equivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that comply with the Islamic law (Sharia) and its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets. 75. Sunnah: The way of life prescribed as normative in Islam, based on the teachings and practices of Muhammad and on exegesis of the Koran. Also called hadith 76. Tadawul Stock Index: Saudi Stock Exchange )( or Tadawul ) (is the only stock exchange in Saudi Arabia. It is supervised by the Capital Market Authority (Saudi Arabia). The Tadawul All-Share Index (TASI) reached its highest point at 68,236,02on 25 February 2006. 77. Tawarruq: in Islamic law is a particular way to be used in order to obtain liquidity needed without getting involved in borrowing on interest. 78. Treasury bills: A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks). 79. Underlying assets: 1- The physical and financial asset to which a security holder or a class of security holders has a claim. An analyst may believe that a stock is underpriced on the basis of the value of the firm's underlying assets and the potential earning power of those assets. Or the asset that underlies and gives value to a security. The underlying asset of a stock option is the stock that the option can be used to purchase. 80. Unilateral: relating to, occurring on, or involving one side only: unilateral development; a unilateral approach. 81. Urbon: is a deposit given to the seller with a condition that if the contract is continued it will be counted in as part of the purchase price, or otherwise it will be for fitted by the seller. 82. Wa'ad: is a promise or undertaking. It is unbinding and has no value; however, in certain circumstances a promise will be valuable and binding. 83. Wadiah (Safekeeping): a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it.

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84. Wakalah (Agency): This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar to a power of attorney.

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Islamic Derivatives In Saudi Arabia

Summary
Surah Al Nesaa: (Quran 4.29) (YUSUFALI: O ye who believe! Eat not up your property among yourselves in vanities: But let there be amongst you Traffic and trade by mutual good-will: Nor kill (or destroy) yourselves: for verily Allah hath been to you Most Merciful!)

This book is a product of five senior students from Al-Yamamah University. It provides information about Islamic Derivatives in Finance. This research mainly discusses Islamic finance and derivatives -in brief-, it also touches upon the probable solution for the integration of financially engineered Islamic Derivatives in the Kingdom of Saudi Arabias economy. This research also- illustrates the reasons behind forbidding some contemporary derivatives in Islam and what other Islamic financial instruments can be used as alternatives to conventional contemporary derivatives. In addition, this book contains the writers recommendations to Saudi Arabia's economy and to Islamic banks to -further- strengthen this sector in the Kingdom of Saudi Arabia. We are trying to convey our message to the financial community in Saudi Arabia -as well as the rest of the world-So that the application of derivatives is exercised properly and in an efficient manner, an application which is in compliant with the rules and regulations set by Sharia or Islamic Law.

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