TYC Finance: ALI

Short selling is a strategy used to profit from the expectation that a stock's price will fall. It's the opposite of having a long position, where you buy a stock hoping to sell it at a higher price later. In short selling, you aim to sell at a high price and buy back at a lower price, keeping the difference as profit.

Let's break it down with an example: Imagine ABC stock is trading at $100 per share. You believe it's overvalued and should be $50. You borrow a share from a broker, sell it for $100, and later buy it back for $50, returning it to the broker. Your profit? $50. But what if the price rises to $150? You then face a $50 loss.

Risk vs. Return: The max return is the price at which you sell the stock. But, the potential loss is infinite, as stock prices have no upper limit. This makes short selling extremely risky.

Margin Requirements: Short sellers must maintain a margin account with the broker. If the stock price rises, they face a margin call and must add more cash or cover their position by buying the stock at a higher price.

Impact on Stocks: Short selling can cause stock prices to overshoot in both directions. When shorted stocks rise, short sellers rush to cover positions, pushing prices higher. Conversely, increased short selling can artificially lower stock prices.

Shariah Perspective:

Most scholars consider short selling to be prohibited.

1. Shares are deemed non-fungible because the underlying is different at each point. What one share represents at one given moment is different to the time you return it. When that is the case, from a Fiqh perspective, shares are not "lent" as in Qardh and lending money, rather they are like borrowing a library book. The risk from a Shariah perspective lies then with the owner, not with you. Therefore, any profit you gain will not be lawful for you.

2. It is unethical to win diametrically at the loss of others.

3. The cost of borrowing a stock is tantamount to Riba. The fee is unjustified for this form of transacting as it is not valid to borrow a stock in the first instance.

4. In addition to that, there are Shariah non-compliance risks with the margin accounts.

5. Short selling bears resemblance to Qimar, or gambling, in financial activities. In short selling, you initiate a position by taking a significant risk, similar to placing a bet, without directly contributing to any value creation. This contrasts with a long position in trading, where risk is transferred through the exchange of assets. The nature of short selling, where risk is created without adding tangible value, renders it akin to an artificial transaction, aligning it closely with the concept of Qimar.

In Islamic finance, the emphasis is on ethical practices and value creation. Any financial innovation must meet the needs of the community while adhering to ethical guidelines. The goal is not to replicate traditional financial practices but to develop alternatives that are both beneficial and compliant with Shariah principles.