Binary option trading

In the Name of Allaah, the Most Gracious, the Most Merciful.

As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.

Introduction:

Binary options trading is a financial trading method in which there are only two possible outcomes, one or the other (1 or 0), hence the name binary. The premise of binary options trading is that you, the trader, guess if the asset will increase or decrease in value by the time the position expires. If you were right, you take away the profit and if not, you lose your investment minus a small percentage that remains in your account. It is either a fixed risk or a fixed reward[1].

Hereunder are some important terminologies of binary transactions:

1. Call option[2] is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period.
2. Put option[3] is an option contract giving the investor the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time.

The call and put options are gambles purchased from the broker and their price will depend on the risk; the higher the risk, the higher the price. The price of the two will be mutually agreed upon between the broker and the investor. An investor purchases a chance based on his assumption.

Call option and put option are two opposites. The buyer benefits through the call option while the seller benefits through the put option.

Every option settles at $100 or $0, $100 if the bet is correct, $0 if it is not.

1. Spot price is the price of the initial price of the asset prior to entering into the investment agreement.
2. Strike price is the expected price upon which the investment is placed.
3. Expiry or expiration date is the time on which the expected investment is based. One will come to know of his gain or loss at this time.

One enters a binary option through a broker. Brokers are either licensed or unlicensed. Licensed brokers make money from the loss of investors, i.e. when using binary options, either the trader or the broker will make money. Another method used by licensed brokers to make money is offering traders a bonus to help them start trading. These bonuses usually come with certain conditions which the traders tend to generally ignore. Hence, it is essential that one reads the terms and conditions of any agreement or contract.

Here is an example of a typical binary call options trade[4].

Zaid decides to invest in binary options. He approaches Fuloos Brokers to invest in crude oil. At that time, the spot price of the crude oil was $92.93. Zaid, the trader thinks that crude oil will be $93 or more at 3:30 p.m. He can buy a call option on that outcome from the broker. The price of the call option will be mutually agreed upon between the broker and the investor. Since Zaid believes the price will increase, he buys 10 call options for crude oil from the broker at or above $93 at a cost of $40 for each call option.

Zaid’s gross profit/loss follows the ‘all or nothing’ principle. If he wins, then for each call option, he gets $100, and if he loses, he will lose his $400.

If the crude oil strike price closes at or above $93 at 3:30 p.m., Zaid’s net profit will be the payoff at expiry minus the cost of the option; the cost of the options purchases was $400. He won the bet, hence he earned $1000: $1000 – $400 = $600. He will earn $600.

Here is an example of a typical binary put options trade[5].

Bakr decides to invest in binary options. He approaches Star Brokers to invest in crude oil. At that time, the spot price of the crude oil was $92.93. Bakr, the trader thinks that crude oil will be $92.50 or less at 3:30 p.m. He can purchase a put option on that outcome from the broker. The price of the put option will be mutually agreed upon between the broker and the investor. Since Bakr believes the price will decrease, he buys 10 put options for crude oil from the broker at or below $92.50 at a cost of $40 each (each put option).

Bakr’s gross profit/loss follows the ‘all or nothing’ principle. He can lose all the money he invested, which in this case is $40 x 10 = $400 ($40 for each put option x 10 shares), or make a gross profit of let’s say $90 x 10 = $900.

Conclusion:

In the binary option of trading, one enters into a contract that is based upon uncertain future events (gharar) and gambling. Therefore, such contracts and transactions will be impermissible[6].

Consider the following Hadith of Sayyiduna Abu Hurairah (Radhiyallahu ‘anh):

نهى رسول الله صلى الله عليه وسلم عن بيع الحصاة، وعن بيع الغرر[7] 

Translation: “Rasulullah (Sallallahu ‘alaihi wasallam) forbade transactions determined by throwing stones, and transactions which involve uncertainty.”

And Allah Ta’ala Knows Best

Muajul I. Chowdhury

Student Darul Iftaa

New York, USA     

Checked and Approved by,
Mufti Ebrahim Desai.

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