Covered Options

The following question and answer by Sheikh Yusuf Talal DeLorenzo attendees of the Dow Jones University Courses on Islamic Investement.Question:: Is covered option Islamic? Why or why not? Answer: An option, whether covered or naked, differs fundamentally from a stock. A stock representsa share in ownership, equity, of a real company producing goods or services and generally contributingto the economy in a substantial manner. When you buy stock, you help to raise capital for business,and the company and the economy benefit. Options, on the other hand (like futures), are intangibles,and a part of what are known as zero sum markets in which gains can only take place if there arecorresponding losses. In other words, if you make a hundred dollars (before commissions), someoneelse has to lose a hundred dollars. This is the sort of circular economic activity that is clearlyforbidden by the Shari`ah. From a purely Shari`ah perspective, however, the form of option to whichyou allude in your question, also known as writing covered stock calls, is prohibited for the reasonthat it involves the sale to another party of nothing more than a right to buy the stocks that you own.Most jurists hold the sale of rights to be prohibited. Proponents of futures and options markets willargue that these activities perform the function of stabilizing prices, regulating risk, and so on.They also argue that there is a value to opportunity. But, the bottom line as far as the Shari`ah isconcerned is that these markets (and transactions) produce nothing of value, and that, as if that werenot bad enough, they operate on the principle that for every winner there must be a loser.Options and futures amount to bets on the direction the market is moving in. Obviously, the ethics ofthis market are unacceptable. And that cannot fail to have negative effects on the bigger picture, orthe economy.