This paper presents a preliminary framework of structuring derivative securities in Muslim stock markets. It is evident derivative markets play a crucial part in the global financial system. It is also a vital contributor to an efficient economic system. However, the Islamic perspective on derivative securities and the possible restrictions to derivative trading has not been closely examined. The paper attempts to fill the gap by presenting the current stance of GCC capital markets. The paper also provides the Kuwaiti experience on options trading and provides recommendations on adequately applying ďSharia-Compliant derivative securities to Islamic financial markets
Key words: Derivative Markets, Emerging Markets, Financial Development, Islamic Finance, Islamic Law
In the contemporary world derivative markets play increasingly more important role. In this respect, derivative securities are particularly important because they contribute consistently to the reduction of possible risks for all parties involved in financial operations. At the same time, the development of derivative markets in the world is extremely differentiated since developed countries, such as the USA, the EU, Japan and others, are characterized by the higher level of stability, while their economies are traditionally characterized as open market economies. On the other hand, there are developing countries, where economies are less stable than in developed countries and, therefore, risks for the development of financial markets are higher. In this respect, it is worth mentioning countries comprising GCC, which have a huge economic and financial potential, but the development of financial markets and business in this region is traditionally accompanied by numerous risks.
In such a context, the problem of derivative securities becomes one of the major challenges to the local financial markets and national economies of GCC. Naturally, in such a situation the role of financial engineering increases consistently because it is these specialists that, to a significant extent, define derivative securities and development of financial markets at large. Financial engineers hold the responsibility of combining designing researching, developing and implementing a range of innovative financial instruments for commercial use. Financial engineers come from diverse backgrounds that include investment and commercial bankers, credit analysts, stock and commodity traders, mathematicians and lawyers. The essence of this science is attaining a solid foundation in economic and options theory. Throughout the paper, the importance of the role of financial engineers, more specifically Islamic financial engineers, in creating derivative securities is proves to be apparent.
This paper presents a preliminary framework of structuring derivative securities in Muslim stock markets. It is evident derivative markets play a crucial part in the global financial system. It is also a vital contributor to an efficient economic system. However, the Islamic perspective on derivative securities and the possible restrictions to derivative trading has not been closely examined. The paper attempts to fill the gap by presenting the current stance of GCC capital markets. The paper also provides the Kuwaiti experience on futures and options trading and provides recommendations on adequately applying ďSharia-Compliant derivative securities to Islamic financial markets
Basically, the paper targets at the research of derivative securities in the context of Muslim stock markets. In fact, the paper researches the basic trends typical for the current situation in Muslim stock markets and identifies the major problems, which expose markets to risks that can undermine stability and make derivative securities ineffective.
To put it more precisely, the paper begins with providing an overview of the evolution of derivative securities. The paper then provides an introduction of options trading. Subsequently, the Islamic view of options and the previous literature are summarized and presented. Furthermore, the paper provides a layout of the importance of such outlines for structuring sharia’-compliant innovative securities.
In addition, it is important to underline that the role of Muslim stock markets and, therefore, derivative securities on these markets is very significant, taking into consideration the current trend to globalization and growing interaction between countries. As a result, nowadays, problems on derivative and stock markets of Muslim countries may affect considerably the situation on financial markets of the entire world. In terms of this paper factors that increase the risks to derivative markets will be discussed, including the lack of benchmark interest rates, limited demand, restrictions on supply, and inadequate infrastructure.
It proves beyond a doubt that the reliability and validity of a research is highly dependent on the methods applied in the process of the research and analysis. In this respect, it should be pointed out that it is necessary to clearly define the research philosophy and conduct the entire research in terms of this philosophy in order to maintain the clear and understandable line of the research. Among the variety of research philosophies, it is possible to select positivism since this research philosophy is based on the use of the accurate scientific approach and it does not admit the possibility of some subjective influences on the research and its outcomes. To put it more precisely, positivism implies that the entire research is based on the use of approaches and data that can be scientifically proved and stand on a reliable scientific ground. In such a way, this research philosophy minimizes the risk of using of uncertain approaches or methods that could put under a question the results of the entire research.
Speaking about the research of derivative securities and their impact on financial markets of Muslim countries and their development, it should be said that it is very important to focus on the use of communication theories which can help better understand the concept of derivative securities in the contemporary highly integrated world, in which communications and infrastructure play a very important role. The research of derivative securities in Muslim context should be also based on reliable theories. For instance, taking into consideration the importance of the formation of a positive brand image in the contemporary market situation, it is possible to focus on the problem of minimization of risks to the derivative securities in Muslim countries through stimulation of the faster development of open market economies in the region.
At the same time, the research of derivative securities in Muslim context will naturally involve the use of the existing researches dedicated to this problem because both concepts are analyzed and researched in details and it is possible to find the recent trends and basic information in the impact of derivative securities from a variety of researchers.
However, it is worth mentioning that many researches (Pine and Gilmore, 1999) recommend using a purely descriptive approach to the study is apparently insufficient. Consequently, the use of exploratory elements will be essential. The use of such research approaches implies the use of basically secondary research because the study will be mainly based on the information that could be retrieved from other studies. At any rate, the current research may reveal the current trends in derivative securities in Muslim stock markets. Taking into consideration the large number of researches dedicated to this problem, it is necessary to update and verify findings of other researches and it is hardly possible to find absolutely new information on derivative securities. This is why it is important to focus on Muslim context and major risks derivative securities may face there. In fact, this is what is really innovative about this research.
In such a situation, it would be logical to focus on the collection of recent data concerning derivative securities and their development in Muslim countries, which refers to the current period of time and recent years. Since the current market situation is characterized by considerable changes under the impact of the implementation of new technologies, globalization, growing interaction between countries, international market expansion of many companies, increasing number of mergers and acquisitions, the data on recent years will give the most reliable information on derivative securities in Muslim stock markets.
At the same time, it is possible to use case studies of different countries and other derivative markets ¬†to analyze the possible impact of derivative securities on the development of Muslim stock markets and development of local economies. To put it more precisely, the use of case studies can help find out effects of derivative securities on the fast development of local stock markets and economy, since economy of Muslim countries is currently emerging and it is extremely important to understand the extent to which derivative securities and existing risks and threats can affect the development of Muslim stock markets and economies. In addition, it is possible to use interviews and questionnaires to find out views of specialists on the problem of the derivative securities and possible risks as well as find possible ways to their elimination.
Also, it is important to research the option markets and contracts, interpret option price quotation, and also it is possible to use the Black-Scholes valuation model to analyze the current situation in derivative securities of Muslim stock markets.
3-The Evolution of Derivative Securities
Derivative securities provide hedging attributions against financial risks to investors, corporations and governments.
Derivative markets play a crucial part in the global financial system. It is also a vital contributor to an efficient economic system. Aside from hedging, derivatives’ function of ďprice discoveryĒĚ is another integral component; derivative markets are able to provide information about market-clearing prices. Futures and options exchanges reflect demand and supply conditions through a broad distribution of equilibrium prices (Jorion 1995). The paper will examine derivative markets and investigate its applications in Kuwait markets relative to global markets.
Recent regulations were effective granting the foreign investor the right to invest in the Kuwaiti market with defined provisions. Portfolio managers around the world are closely monitoring K.S.E performance and regulatory modifications. With local investors, during the past decade, retaining attractive returns in the market, many money managers are trying to apply a portion of their international portfolio in the region and try to capture the observed gains.
Only recently the Kuwaiti Dinar was pegged to the U.S dollar after the linkage it had with a basket of major currencies, making it currently more stable. Pegging the Kuwaiti Dinar to the U.S dollar was part of a long term mutual strategy with the Gulf Cooperative Countries (GCC) in a effort to establish a unified currency by 2010.
Therefore, the countries agreed that the first step was to peg all GCC currencies against the U.S dollar. By that, global portfolio managers would virtually eliminate the possibility of hedging their investments in Kuwait thereby avoiding premium cost. Nonetheless, comparative analysis with global markets would be beneficial to benchmark services and trading activities.
Derivative markets are increasingly becoming a critical part of modern security markets. A major role played by derivative markets can be obtained in three main forms, risk management, price discovery and transactional efficiency As explained earlier, risk management is applied through hedging practices to insure portfolios and large investments, limiting any losses that may occur. In addition, futures and options markets reflect the markets price reaction and hence it provides information about supply and demand on securities traded. Derivatives also contribute to an increase of the economic growth rate since derivatives provide lower transactional costs in financial markets.
The magnitude of derivative markets is statistically evident. At one point in the early 1990’s, total value of derivatives amounted $35 trillion which came close to the total value of securities in the world, $48 trillion. Table 1 presents a consolidated summary of stock markets in relation to the economy as measured by the Gross Domestic Product. For emerging markets, the ratio of stock market size to GDP is 29% and is predicted to increase in the future (Jorion 1995).
However, there are many large investment firms that will not invest in government bonds without any futures contracts being available. The reason being is the need to utilize the ďprice discoveryĒĚ advantage to assist investors in predicting price movement as a risk management tool.¬† Hence, investors who are used to competent derivative markets in developed countries, such as U.S and Japan, would necessitate similar facilities and financial instruments in emerging markets.
Annual GDP ($ Bill.)
|Pacific ex- Japan||
Source: (Jorion, 1995).
Since the inception of futures contracts in the K.S.E, traders clearly demonstrated their preference towards transacting in the cash market as oppose to the derivative market. In 2003, the annual increase in market capitalization in the Kuwait cash market was 78%, while the derivative market witnessed a decline of 22.8%.
Historically, local traders have proved their active role in embracing promising financial tools. In years, 1977, 1982 and 1997, the Kuwaiti market observed how individual traders implicitly supplied inflated attention to new innovative tools. First it was forward trading then the introduction of margin trading in the late nineties. Thus, there is no doubt that with proper educational campaign and profound planning in addition to strict regulatory enforcement, the introduction of options contracts would enhance the probabilities for risk sharing among investors. Thereby, options contracts would be inevitable and that would virtually complete the derivatives market in Kuwait. It is ultimately a positive progress to financial development
4- Options Contracts
An option contract gives the buyer the right, but not the obligation to carry out a transaction involving an underlying asset, security or commodity, at a predetermined price called the exercise or strike price on or before a fixed date called the expiration date. Options are segmented into two forms, Call and Put.
Call Option: A call option is a one-sided obligation whereby the seller (writer) of the call is obligated to sell, but the buyer of the call has the right, not the obligation, to buy a fixed amount of the underlying security or commodity at a fixed price on or before a fixed date.
Put Option: A put option is a one sided obligation whereby the seller of the put is obligated to buy, but the buyer of the put has the right, not the obligation to sell a fixed amount of underlying security or commodity at a fixed price on or before a fixed date.
Options can be designed and created following one of the two choices, European options and American options.
American options can be exercised on the maturity date or at any time between the initiation of the contract and the maturity date, while European options can only be exercised on the maturity date. Hence, European-style option will only be exercised when a gain is realized for the option purchaser.
4.1-Option Contract Terms
The two crucial terms in any option contract would have to involve the exercise price and the option premium. The exercise price, or the striking price is the price the buyer of call will pay, or seller of put, will receive from option seller if the option is exercised. The option premium is the up-front payment made from the option buyer to the option seller that is priced using analytically complex model that would be discussed later in this chapter.
The valuation of an option premium is composed of two main variables, an intrinsic value and time premium. The intrinsic value represents the difference between the spot price and the exercise price. The time value is a function of interest rate, volatility and time left to maturity. An option is said to be in the money when the intrinsic value is positive and out of the money when it’s negative. An option buyer would only exercise the option if the contract were in the money. The table below presents how to determine if an option is in, at or out of the money. Stdenotes the price of the underlying asset and E represents the exercise price.
|In the Money||St > E||St < E|
|At the Money||St = E||St = E|
|Out of the Money||St < E||St > E|
4.2-An Overview of Options Markets and Contracts
Options trading could occur at both OTC markets and exchanges. Indeed, options trading would imply more standardization, automation and liquidity enhancement in exchanges than OTC markets. In exchange-trading, the seller only would be required to deposit a margin account to cover the contract. In the case of the option buyer exercising the option, the broker needs to assure that the buyer’s capital gain is available to be submitted. Information on options is usually remarked as the time of expiration and the exercise price, for example, January 135. January 135 implies that the contract’s exercise price is 135 and will expire on the third Friday in January (U.S market).
4.3-Interpreting Option Price Quotation: An Example
Call Option:¬†¬† Suppose options contracts existed for the National Bank of Kuwait stock. Since one call option allows you to buy 100 shares of stock, the price, the buyer’s payment for one call option is 100 times the quoted call option premium. Also assume that NBK pays 0.10 dividends and the exercise price is 115 fils per share and the quoted premium was 6.20 fils. With the maturity period being in January, the contract would become January 115.
The call buyer decides to purchase one contract. Hence, the premium paid to the call seller (writer) is 6.20 * 100 = 620 fils.¬† The two exhibits below shows that profit/loss percentage of the stock position and the option position to the call buyer both for a rising stock price and a falling stock price.
|Table 2 CALL OPTION CONTRACT FOR NATIONAL BANK OF KUWAIT|
|Stock Position||Option Position|
|Time Interval||Stock Price||Dividend||Jan115|
|Table 3 CALL OPTION CONTRACT FOR NATIONAL BANK OF KUWAIT|
|Stock Position||Option Position|
|Time Interval||Stock Price||Dividend||Jan115|
A call buyer would purchase the option if he/she expects the stock price to rise, thereby leveraging his/her investment. The exhibits 6-1 and 6-2 have demonstrated the substantial profit potential embedded in a rising stock price for the call buyer.
Put Option:¬†¬†¬† A put option is a security that provides you with the right to sell shares of common stock of the underlying company at a specified time during a specified period of time. One put option allows the put buyer to sell 100 shares of stock
Suppose a NBK stockholder would like to hedge his investment. By purchasing a put option it would effectively hedge his position by minimizing the downside affect of NBK price movement. Suppose the investor owns 100 shares, therefore he would hedge by buying one put contract. Similar to insurance purchase, the investor would pay the premium that would protect him from unanticipated losses. Suppose the premium is 6.00 fils and the market price of NBK stock at time zero (T0) is 115.40 fils. The contract would expire on January and the exercise price is 115.
Exhibit 6-3 illustrates the combined position of hedging an investment.
|INFORMATION ON PUT OPTIONS FOR NBK||¬†||¬†||January|
|Time||Company||Dividend||MP on Stock||Exercise Price||Price Premium|
|0||NBK||¬†–||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 115.40||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 115.00||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 6.00|
|1||NBK||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 0.10||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 100.00||¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† 115.00||¬†–|
|PROTECTIVE PUT PURCHASING: NBK (Falling Stock Price)|
|Time||ROR on Stock||Dividend||Option Position||Combined Position|
|0||Buy 100 shares||–||Buy put pay 6.00||will need 121.40|
|1||100||0.1||–||Will receive 115 fils|
|¬†||by exercising the put|
|Results||¬†Loss of 15.40||Gain of 0.10||–||Total Loss of 6.40 fils|
|% Return||(-15.40 +.10)/115.40||–||(-6.40 + .10)/121.40|
|¬†||¬†= -13.26%||¬†= -5.19%|
As demonstrated on Exhibit 6-3, the investor who purchased 100 shares of NBK stock managed to minimize his losses to 5.19% when the stock declined to 100 fils. If the investor did not engage in purchasing a put option his loss on the investment would have been -13.26%. Effectively, the most an investor could lose from purchasing a put on his assets on the stock market is the premium paid.
4.4-The Black-Scholes Valuation Model
In an effort of trying to produce a model that applies a derivative to measure how discount rates of warrants changes with time and stock price, Myron Scholes and Fisher Black jointly developed the illustrious Black-Scholes equation for valuing European-style options. The eminent finance theory developed provided options traders with a simple and a precise valuation technique. The discovery also illustrated how options can be virtually duplicated by a procedure of dynamic trading in the underlying asset.
In essence, the discovery proved that a call option is equivalent to embracing a fraction of the underlying asset, where the fraction changes over time.¬† Therefore, it can be said that a purchase of a call can be replicated by holding a partial stance in the underlying asset (Jorion 1995).
Black-Scholes Valuation Model
The model evidently shows that the price of the call premium is a function of stock price, striking or exercise price, volatility and the risk-free interest rate. Comprehending the logic behind the model can be obtained by segregating it in two parts. The first part, SN(d1), obtains the expected benefit from purchasing the stock outright, it is calculated by multiplying the stock price by the change in stock premium with respect to the change in the underlying stock price, N(d1). The second part, Ke(-rt)N(d2), represents the present value of the exercise price on the expiration day.
Thus, the valuation is computed by taking the difference between the two parts.
The assumptions of the Black-Scholes model are critical to be mentioned, yet the model can be modified to sustain its effectiveness over these assumptions. The model assumes that the stock does not pay dividends; therefore the model could be adjusted by discounting the future dividend from the stock price. The model also assumes that markets are efficient and that no commission is paid. One critical assumption is that interest rates remain constant and known.¬† The model utilizes risk-free rate to support the statement. The value can best be evaluated by obtaining government Treasury bill rate with 30-days left to maturity. Even so, interest rates with significant volatility over a short period of time may limit the model’s effectiveness.
5- The Islamic View of Options
The Islamic view of options has taken two forms in the last decade. Some scholars have observed options under the Al-khiyarat (contractual stipulation) perspective. Others have viewed the contracts similar to bai-al-urbun in which the trader would pay a deposit in advance for an agreement maturing at a defined future date.
Studies that have objected on options justify there disagreement on several bases. For instance, Ahmad Hasan notes that maturity more than three days is unacceptable and states that option buyers are given more benefits than sellers and thereby implying injustice. Further, although Abu Sulayman (1992) finds options to be acceptable, he thinks options should be prohibited because options are completely detached from the underlying asset. Obaidullah (1997) argues that although the general consensus for scholars’ objections is that options involve gharar (speculation), the perceived unearned profits ďignores the fact that both the buyer and seller take on risk and that the buyer also has at stake the premium he has paid.ĒĚ
Mufti Taqi Usmani (also of the Figh Academy, Jeddah) states that when put options were viewed as a promise is acceptable. However, charging fees and trading them are not. Kamali (1997) relates the options contracts to the options of stipulation (Khiyar al-Shart)¬† in Islamic law. Most mathahibs agreed on the validity of khiyar al-shart.
However, different concerns have risen with reference to time and maturity. Kamali (1997) pointed that the Hanafi’s and Shafi’s specified the options should not exceed three days, following what the hadith specified. On the other hand, Imam Malik (ra) has taken a flexible approach stating that three days was used figuratively to convey the concept. Moreover, Imam Ibn Hanbal (ra) points that the length of an option should be specified with the agreement of the two parties. Imam Ibn Hanbal adds that even if the party agrees on not specifying a date, the option contract would still be valid.
As for charging premiums on options contracts, Kamali (1997) found that the majority of the ulama see premiums as unacceptable. Nonethless, Imam Ibn Hanbal permitted the charging of a fee and confirms that Omar ibn Al-Khatab (RA) and his son Abdullah ibn Omar (RA) have practiced it. In addition, followers (tabi’oon) such as Nafi’ ibn Al-Harith (ra) and Zayed ibn Aslam (ra) have solidified its validity. Kamali (1997) also mentions the accepting views of Sheikh Yusuf Al-Qaradawi and Sheikh Mustafa al-Zarqa to the authenticity of Bai’ Al-Urbun.
An extensive study on the legal status of bai al urbun performed by Mohammed Al-Amine, stated that what is paid in urbun ďis in exchange for the right to cancel the contract and not compensation for damage. Al-urbun could, in essence, substitute the conventional options as it provides investors with flexibility of risk reduction strategies to minimize loss prior to committing to large investments. By that, the loss would be limited to the initial premium paid. ¬†This is effectively the equivalent to call options on which the buyer pays a premium to secure the write of purchasing an underlying asset in a specified future date.
However, the put option (the write to sell or the obligation to buy) has been a concern especially when the buyer cannot meet his obligation. El-Garie proposes a framework to remedy this concern that is similar to ijarah. El-Garie proposes that the ďcontract should involve the rendering of the service to a certain partyĒĚ. The party suggested could be the stock exchange or a clearing house. Vogel and Hayes also suggested the involvement of a third party in which the customer could use a bank as a guarantor.
Objections were also documented on the underlying assets not being a commodity. It is clear that the literature on this matter agreed that Ēėurbun’ could not be used for currency, stock indices or interest rate option trading.
As for the arguments that price of options are determined through interest rates, several alternatives were proposed that could bypass the link of interest rates. AlAmine stated that the in the Ēėurbun’ market does not determine price through interest rates. In addition, it is advocated that the alternative of options should be conducted in the primary market. Hence, it could be argued on the legitimacy of the Islamic alternatives traded in the secondary market.
Some refused options on the basis that it involves a future sale. Yet, Islamic law has accepted the idea of future sale such as bay’il moajjal , salam and the istis’na’. Therefore, previous objections of options, namely the ur’bun market, in islam is found to be legitimate and compliant with Islamic sharia’ as stated by Al-Amine. The preliminary structure suggested is the u’rbun being the alternative to call options and reverse urb’un as the alternative to put options.
6- Introducing Options Market in Kuwait
Some forms of derivative securities exist in the Kuwaiti market. Trading derivatives became more evident in 1970’s when forward trading was the dominant financial instrument extensively applied in the Kuwaiti OTC market. Large banks in Kuwait along with other banks and large investment firms around the world employ currency and interest rate swaps. In late 1990’s, Futures trading was introduced to the market. Futures contracts are traded in the Kuwait Stock Exchange. Options trading were recently established. However, only a portion of options contracts was effective. Options on stocks are currently limited to thirteen listed companies and with only the call option instrument available. Recent announcements declared that the put options will be introduced from six months to a year following the introduction of call options to the market.
6.1-Current standpoint of Kuwait Stock Exchange¬†¬†¬†
Although an emerging market, Kuwait Stock Exchange has became one of the most sophisticated exchanges in the region. The exchange customized and uniquely developed computerized trading system and adequate organizational structure along with its responsiveness to financial innovations and exchange developments has made the exchange amongst the leading and most attractive exchanges in the region.
As to date, the KSE has recently introduced options trading in the market in which it is the first market in the Middle East to do so. In conjunction with Kuwait Financial Center, Kuwait Clearing Company and the KSE Management, the ďForsaĒĚ fund was developed and approved for the market. Its an open-ended fund created by Kuwait Financial Center ďAl-MarkazĒĚ to engage in various investment trading strategies, part of which act as a writer to call options of thirteen listed underlying stocks.
Historically, local traders have proved their active role in embracing promising financial tools. In years, 1977, 1982 and 1997, the Kuwaiti market observed how individual traders implicitly supplied inflated attention to new innovative tools. First it was forward trading then the introduction of margin trading in the late nineties. Thus, there is no doubt that with proper educational campaign and profound planning in addition to strict regulatory enforcement, the introduction of options contracts would enhance the probabilities for risk sharing among investors (Al-Abdul Jader, 2004). Thereby, options contracts would be inevitable and that would virtually enhance the derivatives market in Kuwait. It is ultimately a positive progress to financial development.
7. Factors affecting the development of derivative securities markets
Basically, nowadays, it is possible to identify several factors that affects derivative securities of Muslim countries and, as a rule, produce a negative impact or, at any rate, expose derivative securities markets to significant risks and threats. In this respect, it is possible to identify the following factors: the lack of benchmark interest rates, limited demand, restrictions on supply, and inadequate infrastructure.
First of all, it is important to underline that the low benchmark interest rates is the most critical factor that impedes the smooth development of fixed-income derivative securities markets. Largely because of the direct and indirect control of interest rates, the demand for government-issued bonds is lacking. As a result, the primary market activities of government bonds must rely on captive financial institution, which rarely sell their purchased bonds on the secondary markets.
Speaking about restrictions on supply, it should be said that a wide range of statutory restrictions and financial regulations severely limit the issue of long-term fixed-income securities by financial institutions and corporations. As for inadequate infrastructure, it is worth mentioning that contractual saving institutions, a competitive auction system in the primary markets, secondary market trading system, clearing and settlement systems, and rating agencies have yet to be either reinforced or developed.
In such a way, it is obvious that the potential risks that derivative securities and Muslim financial market can face are basically related to the lack of open market economy and imperfectness of the governmental regulation of national economies as well as derivative securities markets. At the same time, it will be quite difficult to overcome these risks and prevent their appearance in the future, because of political and cultural peculiarities of Muslim countries. In fact, the role of the state in these countries is traditionally very strong, while the introduction of open market principles and liberalization and improvement of the situation on derivative securities markets is substantially slowed down.
Conclusion: Future Outlooks of Derivative Securities in the Islamic Financial Markets
The development of a competent derivative market and the intensification of financial innovation have led to continuous improvement in structuring derivative financial products. As observed in many developed markets, the prerequisite of today’s publicly traded equity derivative products are options on common stock. Since options on common stock was recently regulated and implemented, it is inevitable for KSE and other Islamic financial markets to fulfill the customer needs for the development of financial products that would contain a wide investor appeal, many of which qualify for listing and trading, commonly known as listed equity derivatives.
Yet, the compliance of options with the Islamic law would be a necessity. It is advocated that the Islamic financial engineers would convey the concepts and the benefits of derivatives properly and accurately to our scholars for just judgments. It is clear that previous concerns and objections on options can be modified and designed to comply with the Islamic law. This potential market calls for further investigation and the intensification of efforts in setting the framework of an ďIslamiclyĒĚ acceptable derivatives market to facilitate risk in the Islamic financial market.
Finally, derivative securities in the Islamic financial markets can develop progressively on the condition of the minimization or even total elimination of the existing risks which can deteriorate substantially their development and, even nowadays, such problems as low benchmark interest rates, inadequate infrastructure, limited demand and restrictions on supply limit consistently derivative securities markets in Muslim countries. Consequently, the elimination of these risks may be viewed as a strategic goal of the future development of derivative securities markets in Islamic countries. At the same time, the solution of such serious problems should be the subject of a profound research in order to conduct changes and reforms in the market in a possibly shorter term with a maximum effectiveness.
 See Hashim Kamali pg.37-38