Investors often become curious if forwards and futures are permissible in Islam because they are important financial products. There are some different articles about its impermissibility in Islam. Stating that they both are prohibited because the contracts do not comply with the Islamic law principles. So, today we discuss if forwards and futures are really impermissible and what are the reasons behind.
What Are Forwards?
Forwards are financial derivatives reaching settlement upon contract termination. It is an arrangement where the buyer and the seller negotiate and agree on the contract terms—such as its expiration date, what underlying asset should they deliver and other elements. Considering the characteristics of the contract, forwards are not traded on an exchange.
What Are Futures?
Futures contracts bind the buyer to purchase or the seller to sell an asset at a set price at a pre-agreed future date. These types of contracts have fixed maturity dates, and they are traded on an exchange. So, futures contracts adjust to daily market fluctuations throughout the contract’s duration.
Are Forwards and Futures Permissible in Islam?
Shariah Scholars believe that 3 aspects of forwards and futures are problematic in Islam:
- Both forwards and futures permit an individual to buy goods that do not exist when signing a contract. It is against a fundamental principle of the Islamic law that specifies goods at the time of actual agreement.
- Even if forward or futures exist at the time of contract, they both allow the trader to sell the goods even before owning that property (i.e., short-selling). Thus, it opposes another principle of Islamic law that demands a seller to have ownership of the object at the time of the contract.
- Forwards and futures allow buyers to resell the goods or set the contract obligations before actual delivery. According to Shariah, physical delivery of the object must happen before resale or settlement. For sure, it violates the possession-and-delivery (qabdh) criteria of Islamic law.
These three requirements (existence, ownership, possessions) are essential from an Islamic perspective. Therefore, forwards and futures are not permissible in Islam. If we miss any of the above-mentioned elements, we can consider the contract invalid because of the presumption of gharar.
Even though conventional forwards and futures are not Shariah-Compliant because they violate the three requirements, Islamic jurisprudence offers some other examples of contracts that do not fulfil the three requirements but accept them as exceptional cases.
Forward and Futures as Hedging Purposes
Islamic financial institutions (IFIs) use a variety of contracts in shariah that have features similar to derivatives for hedging, such as salam, istisna, urbun (earnest money), and hamish jiddiyyah (security deposit).
In addition, IFIs use some of Islamic contracts to create products with features similar to forwards and futures. Such contracts are including commodity murabahah, musawamah, bay al inah, bay bi thaman ajil, tawaruq, and wa’d
Islamic banks only use derivatives are for risk management and hedging purposes. Islamic derivatives are used to protect against currency fluctuations. Furthermore, Islamic banks also use them to protect against price fluctuations in commodities. Islamic financial institutions and businesses would incur significant losses if Islamic derivatives and hedging mechanisms were not available.
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FAQs
These three requirements (existence, ownership, possessions) are essential from an Islamic perspective. Therefore, forwards and futures are not permissible in Islam. If we miss any of the above-mentioned elements, we can consider the contract invalid because of the presumption of gharar.
Why is future trading haram in Islam? ›
1. *Speculation*: Futures trading involves speculating on the future price of an asset, which is considered a form of gambling (Maysir). Islamic law prohibits gambling and any transactions that involve excessive uncertainty (Gharar).
What are the limitations of forward contract? ›
There are several key disadvantages of a forward contract. For instance, their details are not made public, as they are negotiated privately between the two parties involved and because they trade over the counter. They offer more flexibility but also have higher counterparty risk.
Are futures and options halal? ›
Some pupils agree with that options trading is permissible, at the same time as others trust it isn't. The majority of Islamic students accept as true with that margin trading, day trading, alternatives, and futures are forbidden by using sharia.
Is Investing Permissible in Islam? ›
The statistics depict a rise in both demand for halal – or “sharia compliant” – investments and opportunities. Investing is permitted under Islam, but certain aspects of investment practice – such as charging or paying interest – are not.
What are the risks of futures? ›
Market Risk: The most obvious risk with futures trading is that prices can be highly volatile, and changes are can be swift, adverse, and devastating. 11 This is because the market risk is magnified by leverage, when there's already enough to worry about when supply and demand shift.
What are the pros and cons of currency futures? ›
Future contracts have numerous advantages and disadvantages. The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.
What are the advantages of options over forwards and futures? ›
The most important advantage is that an option is not binding, in the way is does not obligate one to buy a commodity. It gives you the right to buy it and so when the price of the option is higher than the current market price you can just let the option expire and buy at the spot price.
Why futures and forward prices might differ? ›
Exchange-traded Futures Contracts
Each day, the parties to the transaction must maintain their margin accounts. This daily cash flow means there isn't a “lump sum” to exchange at contract expiration. This differing cash flow pattern can produce a pricing difference relative to an equivalent forward contract.
What are the advantages of a forward contract? ›
Advantages of Using a Forward Contract:
A forward contract can protect you from unforeseen currency rate changes. Lock in a Favourable Exchange Rate: Securing a forward contract allows you to lock in a favourable exchange rate when making the initial deposit.
Forward Contract Cons:
The price or exchange rate could move against you, and you end up paying more than the standard price in the future. A forward contract is more complicated than a standard contract.
Is forward contract safer than futures contract? ›
Since forward contracts are also speculative, they can be incredibly risky for the buyer. Future contracts are settled with cash. However, forward contracts are usually settled after the delivery of the asset however cash-settlement is also possible.
What is a disadvantage of a forward contract quizlet? ›
Disadvantage: Forward contracts are subject to default risk, and the only recourse for a counterparty defaulting on its contract is to take legal action, which can be costly and lengthy.
Is prediction trading halal or haram? ›
Is trading halal in Islam? Trading is considered halal in Islam if it adheres to Islamic financial guidelines, such as avoiding transactions involving interest (Riba), excessive uncertainty (Gharar), gambling (Maysir), and trading in haram (forbidden) items.
What type of trading is haram in Islam? ›
Islam has prohibited traffic in wine, swine, dead bodies of animals and other goods the use of which has been declared to be Haram (unlawful). It has also forbidden trading in things that have a debasing or vitiating influence on the Muslim society.
Is day trading futures halal? ›
Margin trading, day trading, options, and futures are considered prohibited by sharia by the "majority of Islamic scholars" (according to Faleel Jamaldeen).
Why is day trading haram in Islam? ›
It has been narrated that the Prophet Muhammad ﷺ “Do not sell that which you do not possess.” By not owning a possession, the seller has no power to guarantee it and hand it over to the purchaser, making it a gamble. Therefore, Islam may have some issues with day trading.
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