Floor-Pricing Without Put Options: Hedging by Trade Contracts in Islamic Finance as Exemplified in Agriculture Production

Abstract

Conventional methods of hedging, such as the use of put options, have long existed in trade with their use being justified for managing price risk. However, many Shari’ah scholars find issues in their implementation on various grounds that are based on the principles of achieving economic equity. The method proposed here aims to achieve floor-pricing as a hedging tool for producers, using common accepted trade contracts. This aims to avoid existing contentions in hedging amongst differing scholarly views, while recognizing proper rights and obligations of stakeholders. This conceptual paper analyses the needs of hedging in the context of an agricultural production setting, touches on currently known hedging mechanisms together with their known issues and puts forth an alternative method. Implementation issues of this method is discussed and proposed ways to address them are included. This method does not address hedging for buyers and utilizes the Salam contract, which is not suitable for addressing hedging of currency exchange.