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Financial Engineering with Islamic Options

In view of the central role which options play in mainstream financial engineering – in design of innovative financial products and management of risk, this paper undertakes an Islamic evaluation of options and its role in the Islamic system of financial contracting. An Islamic assessment of options as independent contracts in themselves and as embedded features in more complex financial products, reveals some interesting possibilities. While there is a lack of support among Islamic scholars on the use of options as independent contracts, the Islamic system of contracting allows for designing risk management solutions using the framework of khiyar al-shart. The paper analyzes and discusses the case of a specific Islamic contract, istijrar and highlights its possible use in managing certain forms of risk. A comparison of istijrar with some conventional financial products shows that some insights from mainstream options-related literature may enable the Islamic financial engineer to design the contract in a more efficient manner.