Are inverse ETFs, stock options and naked options permissible?

An inverse ETF, also known as a “Short ETF” or “Bear ETF”, is an exchange traded fund (ETF) constructed by using various derivatives to profit from a decline in the value of an underlying benchmark. Investing in inverse ETFs is similar to holding various short positions, which involve borrowing securities and selling them with the hope of repurchasing them at a lower price.¹

Inverse ETFs typically use derivatives, such as daily futures contracts, to produce their daily inverse returns. This introduces one of the primary benefits of inverse ETFs, which is that they allow investors to make bets that a benchmark will decline without having to directly purchase derivatives.

In the case of inverse ETFs, the futures contracts held by the fund are betting that the price of the benchmark will go down. If successful, the shareholders of the inverse ETF will profit. But if the benchmark asset or security rises in price, the inverse ETF will decline. ²

Options are a form of derivative contracts which entails an agreement between two parties to facilitate a potential transaction on an underlying security at a pre-set price, referred to as the strike price, prior to or on the expiration date. A naked option is a variation of an option contract where the seller does not own the underlying asset/security required to meet the potential obligations that would arise from the option being exercised.

Inverse ETFs, whether leveraged or not, are made up of derivatives contracts. Derivative contracts, including options,are prohibited in terms of Islamic law due to containing some or all of the following elements:

1. Promises converted into sales without offer and acceptance
2. Sale that is executable on a future date
3. The absence of subject matter for a valid sale
4. Gharar Fahish(excessive uncertainty)
5. Maysir(gambling)
6. Riba(Interest)

AAOIFI Shariah Standard No. (20) prohibits derivatives on the basis that they constitute binding promises that are converted into sale contracts pertaining to the future without offer and acceptance. It prohibits options on the basis that the subject-matter of the contract does not satisfy the Shariah requirements.

Mufti Taqi Uthmani (Hafizahullah) states in his Fiqhul Buyu’ that the seller in options contracts does not deliver any recognized asset to the purchaser, nor does he transfer any financial right, which means that options contracts fall under the purview of consuming the wealth of people through illicit means. He further expresses that these contracts resemble gambling more than they do trading given that the seller of the option does not own the commodity that he committed to sell, and he only entered into this arrangement on the basis of future predictions regarding the commodity price, essentially speculating on the price movement.