Dear Hadi,
Dear Future Fortunes,
Thank you for this interesting question. Once again, in this column, we try our best to give advice, and do not give fatwas. Moreover, your question deals with a very specialized topic which would need a specialized fatwa board (Islamic scholars specifically trained in financial law).
Therefore, the short answer to your question is: we don’t know. However, that’s not why you came here, so let us say we don’t know, but in a longer and more detailed way, where we can give our thoughts and advice, and God knows best.
The first issue is that haram is a big word, and people who use it have to be very careful. Our approach to all such questions is guided by the general principle of Islamic jurisprudence that the basic nature of things is that they are halal (allowed) unless explicitly prohibited. This is very well summarized by the eminent 20th century scholar Yusuf Al-Qaradawi at the beginning of his book Al Halal wal Haram fil Islam (The Lawful and Prohibited in Islam). His first chapter heading is titled: “The Basic Asl’ (Principle) Refers to the Permissibility of Things” - in that chapter, he states: “The first asl, or principle, established by Islam is that the things which Allah (SWT) has created and the benefits derived from them are essentially for man’s use, and hence are permissible. Nothing is haram except what is prohibited by a sound and explicit nas (either a verse of the Quran or a clear, authentic and explicit sunnah) from the Law-Giver. If the nas is not sound, as for example in the case of a weak hadith, or if it is not explicit in stating the prohibition, the original principle of permissibility applies.”
Futures trading (and financial derivatives in general) are a very new financial instrument, certainly not around in the days of the Prophet (pbuh), and so there is no explicit statement regarding them. We feel that the best that can be done (by a specialized fatwa board as above) would be to reflect them in the mirror of the general principles of Islamic financial dealings, and see how they comport. That is what we will try to do by way of sharing our thinking on the matter, and then the decision of course is up to you.
For the benefit of our general readers, we will go into some detailed examples that you probably do not need. First, let us define a little bit what futures are. In general, a futures contract is, in its original (early) formulation, an agreement between a buyer and seller to exchange a certain amount of commercial goods, usually with a specified quality, for a specific price and on a specific future date. So, A and B agree, for example, that A will sell B a bushel of wheat for $6 on January 1st, and they have a contract to that effect. In other words, futures trading involves entering into contracts to purchase and sell assets at a future date, at a price agreed upon today. This is different from the situation where a good is delivered now but payment of an agreed-upon price is deferred to a later date, which is generally considered to be okay.
To begin thinking about the issue of futures, let’s look at the general principles of financial dealings in Islam. The key principles that govern Islamic finance include the prohibition of riba (usury), gharar (excessive uncertainty or ambiguity), and maysir (gambling). These principles aim to promote fairness, transparency, and ethical behavior in financial dealings.
Probably the most important principle in the case of futures is that of gharar. Gharar is a term which refers to a mix of uncertainty, risk and deception. The typical example is sale of products which are not present, such as selling fish in the ocean (on the presumption that you will catch them), or selling the unborn calf (on the presumption that it will be born alive and well), etc. There are several hadiths of the Prophet (pbuh) saying, “Do not sell what you don’t have.” That is because there is an element of uncertainty as to whether you will truly have what you have promised and have been paid for, and its quality is not yet clear, etc.
The general scholarly opinion is that futures contracts should thus be avoided because they contain elements of gharar. On the other hand, some modern scholars note that when dealing in regulated futures markets, contract and delivery terms are more standardized and thus the remaining uncertainty is minimal, thereby potentially making the transaction permissible. Thus, the sharia perspective on futures trading is nuanced and can vary depending on the specific nature of the contracts and the assets involved.
For ourselves, we feel that the original formulation of futures contracts, based primarily on the sale of some agricultural products, may be acceptable in today’s economy, since a seller may need to take “pre-orders” for the crop he will grow or the product he will manufacture, to allow him the capital to do the farming or manufacturing. It would be best, of course, to enter into a business partnership where someone provides capital, and then the crop or product is sold, and the farmer is paid for his labor and the investor recoups his capital hopefully with some profit for both, but we recognize that this may not always be possible.
That being said, we note that futures trading as it is done today has significantly changed from this simple original formulation, and the face of the practice as it stands today gives us significant concern regarding its advisability in terms of Islamic financial ethics. We will not (and cannot) say haram, but much of it makes us quite uncomfortable.
To explain that, let us state that futures trading is currently done for two main purposes: hedging and speculation. Hedging involves attempts to reduce the amount of risk associated with a commodity’s price change. For example, a manufacturer needs to feel comfortable that he will be able to get supplies at a certain price down the line, or a farmer wants to feel comfortable that he will be able to get a certain minimum price for his crop. Futures trading can be used to hedge against the risk of price change. As an example, a farmer wants to lock in the current price for his wheat crop (being planted now and to be harvested later) of $6 per bushel. He can enter into a futures contract for that amount, say for January 1st. We will, for the moment, simplify that transaction, and get back to the simplification in a little bit. If, on January 1st, the actual market price of the wheat has dropped to $5, the farmer has guaranteed, through his futures contract, that he will instead get the $6 he wanted, so he mitigates his risk against the price drop. On the other hand, if the price goes up to $8, he still has to sell for $6, so he loses potential profit that he could have made if he did not have the futures contract. So, in essence, he hedges against loss by foregoing potential profit.
In today’s marketplace, with the large economies present, we feel that hedging to reduce risk may be a legitimate use of futures trading, while recognizing that it does conflict with the hadith of the Prophet (pbuh) quoted above, where the Prophet was talking about small individual transactions. That is because financial dealings now are a very different scope and this sort of hedging may become necessary for economic viability if no other alternatives are available (and God knows best).
However, most futures trading is actually not used for hedging, but rather for speculation. That is, an investor A, who has no particular interest in crude oil, enters into a futures contract anticipating that the price of crude oil will go down at the turn of the year (in essence, betting on that). For example, he contracts with B that B will buy from him a certain amount of crude oil at $90 per barrel. However, on January 1st, the price of crude oil has fallen to $80 per barrel. Therefore, investor A can buy it for $80 per barrel at the market price, and sell it to B at the contract price of $90, making $10 per barrel. Thus, A bet the price would go down, while B was betting it would go up, and A won, and his speculation paid off.
There are a few issues here. First, investor A is not in the oil business at all, and he was just using oil as a commodity to basically speculate on its price. In today’s world, A never actually takes possession of the oil at any step of the transaction. The futures contract has been divorced from the actual commodity. What happens, instead, is that the contract is settled in cash – i.e., B says to A, we gambled, you won, I lost, and I will therefore pay you $10 per barrel for the number of barrels we contracted on (the difference between the $90 dollar price agreed upon in the futures contract and the $80 current market value of oil). Therefore, A does not actually sell oil, and B does not actually buy oil. The futures contract was just being used as a speculative instrument. Speculative trading is thus generally viewed negatively due to its resemblance to maysir (gambling). We agree with that assessment. Islamic finance emphasizes real economic activity and transactions involving tangible assets, which will be a net value added for society in general. The above transaction does not do that. To quote Warrior Trading from their webpage, A Beginner's Guide to Futures Trading, “trading in futures can often dwarf the trading in the underlying physical asset, such as oil futures, with many times the value of futures contracts changing hands than there is trading volume for the underlying asset.” More explicitly, to quote the Finbold webpage What is Futures Trading? | Simply Explained | Beginner’s Guide: “Speculators are individual investors who want to benefit from the underlying asset’s price movements and don’t want to receive the physical assets. Their only interest is to earn a profit from trying to predict the price changes…”
There is a second major issue with current futures trading. The above example used a physical commodity (crude oil). However, much of the futures market is not about commodities at all, but about financial futures and currencies. In effect, investors will speculate on the price of certain stock indices, or currency exchange rates (including bitcoin), trying to make money on the changes in price of these financial products, completely divorced from any physical or tangible assets. We feel that this has very little value added for society, as it is in essence educated gambling on which way stock prices or currency exchange rates will move.
The final issue is that of leveraging. That is where an investor buying a futures contract needs to only put up a small “margin” of the money for the whole contract – typically in the range of 10%, with the rest being borrowed from the futures broker. Again, from the Finbold website, “Usually, the futures exchanges’ initial margin amount is around 3% – 10% of the underlying contract value... This higher leverage allows investors to gain higher profits by having less equity. However, it can equally put you at risk of losing more money than initially invested.” Let us make that concrete. You enter into a futures contract for $500,000. However, you only have to pay 10% of that amount (because you are “leveraging” the deal). Now, let us say the price of the assets when the contract is due is $600,000, and you are on the losing end. You guessed wrong on the speculation, and the market moved against you. Thus, you lost $100,000 – you not only lost your full original $50,000, but now you owe an additional $50,000. This leveraging aspect is what makes futures trading so attractive to some investors – if you had guessed right, you would have made $100,000 on an investment of $50,000. However, in essence, it is often gambling with money which you don’t even have, and can lead to disastrous consequences, including financial ruin.
Therefore, in summary, we feel that in its original formulation, and for the purposes of hedging, futures trading may have been acceptable. However, in its current form, for the purposes of speculation, divorced from actual commodities, and potentially leveraged with extreme amounts of risk, we have serious concerns about its Islamicity (pun intended), and God knows best. Once again, this is just our opinion, and not a fatwa. We would suggest that for an issue this intricate, that you consult detailed sources on Islamic finance or a specialized fatwa board.
Finally, we note that there are efforts within Islamic finance to create Sharia-compliant financial products that serve similar purposes as conventional futures but are structured in a way that aligns with Islamic principles. These may include Salam contracts (forward contracts in which the price is paid in advance) and other risk management tools that comply with Islamic law.
We hope this helps.
In peace.