Derivatives are few and far between in countries where the compatibility of financial transactions with Islamic law requires the development of sharia’s-compliant structures. Islamic finance is governed by the sharia, which bans speculation and gambling, and stipulates that income must be derived as profits from the shared generation of goods and services between counterparties rather than interest or a guaranteed return. The paper explains the fundamental legal principles underpinning Islamic finance with a view towards developing a cohesive theory of derivatives subject to sharia’s principles. After critically reviewing accepted contracts and the scholastic debate surrounding existing financial innovation in this area, the paper offers an axiomatic perspective on the principle-based permissibility of derivatives under Islamic law. During the recent financial crisis, derivatives have come into sharp focus on account of their complexity and their role in precipitating and propagating the economic fallout. The crisis caused a global realignment of risk premia, a widespread retrenchment of credit exposures, and substantial intervention measures by governments and central banks alike. The populist criticism, however, tends to ignore the vast economic gains from efficient risk management associated with derivatives. Derivatives have real value if they are applied with judgment based on a good understanding of how they facilitate financial intermediation, especially in instances of high transaction costs, poor liquidity due to the dispersion of markets, and limited asset supply or the conglomeration of many risks into one asset.4 Therefore, the main economic rationale for the wide availability of derivatives stems from their role in the diversification and transfer of risk, which allows economic agents to reduce funding costs and hedge risks associated with certain transactions.