What Is a Call?
A call usually refers to one of two financial concepts. Let’s explore both of them to understand their significance.
Exploring Call Options
A call option is a derivative contract that gives the owner the right, but not the obligation, to buy a specified amount of an underlying security at a predetermined price within a specific timeframe.
- Call Option Explained: A call option grants the right, but not the obligation, for a buyer to purchase an underlying instrument at a given strike price within a stipulated time period. These instruments could range from stocks, bonds, foreign currencies, commodities, or any other traded financial security.
- Strategy Uses: Call options are used for speculating on upward price movements, managing risk, or establishing covered calls. If the strike price is below the market price upon expiration, the option can be exercised for a profit.
Example of a Call Option
Imagine a trader buys a call option for $2 with Apple’s shares at a strike price of $100, set to expire in a month. If Apple’s shares trade at $120 at expiration, the trader can buy them at $100, benefiting from the $20 price difference per share, minus the premium paid.
FAQs about Call Options
How Do Call Options Work? Call options are derivative contracts that give the holder the right, but not the obligation, to purchase shares at a strike price. If the market price rises above this strike price, the holder can buy at the strike price and potentially sell at the market price for profit. However, if the market price does not rise above the strike price, the option expires worthless.
What Does It Mean to Buy a Call Option? Buying a call option reflects optimism (bullish sentiment) about the underlying security. It provides leverage, offering an attractive way for investors to speculate on a company’s growth.
What Are Put Options? Put options are the opposite of call options. They give the holder the right to sell an underlying asset at a specified price before the option expires.
How Do I Sell a Call Option? Options can be traded on exchanges. Selling or writing call options can be done to close an existing position or to take a short position in the market. When combined with ownership of the underlying asset, it’s known as a covered call strategy.
What Happens If My Call Expires In-the-Money? If a call option expires in-the-money (ITM), meaning the strike price is less than the market price, the holder can exercise the option to buy shares at a lower price, realizing an immediate profit. Conversely, an out-of-the-money (OTM) call will expire worthless.
Unpacking Call Auctions
A call auction involves trading securities within a predetermined timeframe where buyers and sellers submit their respective maximum and minimum acceptable prices. This method is common in smaller exchanges, increasing liquidity and reducing volatility.
- Call Auction Explained: Buyers and sellers define their price limits during a call auction. All trades are executed at a single clearing price determined during the auction, making the process transparent and efficient for price discovery.
- Government and Call Auctions: This method is also used by governments for selling treasury notes, bills, and bonds.
Example of a Call Auction
Suppose stock ABC’s price is set by a call auction with three buyers: X, Y, and Z. X wants 10,000 shares at $10, Y wants 5,000 shares at $8, and Z orders 2,500 shares at $12. Because X places the highest aggregate buy order, they secure the stock at $10 per share, with Y and Z also filling orders at the same rate.
Key Takeaways
- Definition Variance: ‘Call’ can refer to a call option or a call auction.
- Call Option Rights: Grants buyers the right—but not the obligation—to purchase an asset at an agreed price.
- Market Auction Benefits: Call auctions help determine prices in less liquid markets.
By understanding call options and call auctions, traders can make more informed decisions, leveraging strategies suitable for varied market conditions.
Related Terms: put option, strike price, market liquidity.
