Calls through debt set-off (muqaddasah). AAIOFI shariah standard number 3 states that setoffs are possible as long as they involve the same counterparties (e.g., I owe you and you owe me) and the notional is the same and the maturity is the same. These can even be made contractual. There is also some leeway if notionals are different and maturities are different. Here we stick with the basic set-off.
In the diagram above we see the cashflows for a call-option. This structure was used for Principal Protected Commodity Notes (just adding on a separate SPV with murabaha to synthesize the zero-coupon bond) by some large commercial Saudi banks and super-large continental European banks.
- Investors puts up $C (call premium) at t=0, which is supplemented with the Murabaha (effectively borrowing $(K-C) strike price less call premium-worth of a commodity at time t=0).
- The commodity is sold on the open market to raise $(K-C).
- The premium and proceeds of commodity sale with total value of $K are invested in a Bay-al-Salaam contract.
- This Salaam contract is used as collateral (through a "pledge") for the Murabaha and recourse to the SPV is limited to this Salaam contract.
- At maturity, the commodity is delivered and will be sold (on the open market) under a separate wakala arrangement.
Now there are two possible scenarios at maturity t=T
- Commodity price P>K the strike. Commodity is delivered into salaam, sold, proceeds used to cover the monies owed in murabaha, and remainder $(P-K) is paid to investor.
- Commodity price P
the strike. In this case, the commodity is delivered and sold, but proceeds cannot cover the murabaha and the bank will exercise its recourse to receive the value from the proceeds of the salaam sale. SPV is wound down with no further recourse.
Effectively, investor receives max(P-K,0) at time t=T, the payoff of a call option.
IMHO, I see no loopholes in this. Debt set-off is allowed and it can be contractual. Here, the salaam and the murabaha have the same maturity and same notional, so what is owed on one can be used to offset the other by contract with no further recourse or implications. The SPV and pledge allow is to take place from an English Legal perspective.