Several meanings of the word “call” exist in the financial field. It refers mainly to the following subjects:
- a call option;
- a call auction.
Concerning call options, it means a special type of contract that grants the buyer of the call the possibility (with no necessity) to purchase underlying securities such as stocks, bonds, interest rates, etc. under stated conditions (quantity, price and time).
If the word “call” refers to a call auction, it means an event at an assigned time at which the participants of the auction set their acceptable prices (the highest and the lowest allowable for buyers and sellers respectively). A call auction (another possible name is a call market) is a convenient way to establish security prices for the situations when the assets are illiquid. The procedure of a call auction results in rising liquidity and a mitigation of volatility.
The rest of the possible uses of “call” in the financial field includes a process of paying off the bonds of a debt borrower (calling back), and different types of conference calls between a company and other parties.
A call option, as it has been stated before, is a special contract with a list of established conditions. There are two participants engaged in it - a writer (or a seller) and a holder (an owner). Call options are usually sold and bought on an exchange, where a buyer pays the seller a fee called a “premium”. One call option is a contract, and it usually is one hundred shares of the underlying security. Call option prices are usually represented by per-share price, which means that the whole price must be calculated and taken into consideration with the cost of the premium. It’s an important thing to remember to predict possible losses and benefits of the call option.
A wide spectrum of assets may be used as a security for a call option, and a precise amount, price and time of purchase are stated in the contract. The stated price in a call option is called a strike price, and the purchase typically happens when it’s less than the market price. Call options are different from stocks because they don’t exist for an unstated period of time and have a fixed expiration date. Time period of a call option is usually limited, so an owner has to make a decision whether he or she wants to exercise it or not. But a call option is not an obligation for an owner, that’s why if the market price is less than the strike one at a stated time, an owner doesn’t have to exercise the option, so it expires and turns worthless.
Call options are well-known and attractive to traders because the loss of the owner is limited only to the cost of the premium. A call seller gains the premium, but if a buyer decides to exercise the call option, a seller is obliged to sell the assets for a price stated in the contract. At the same time, selling call options is also attractive for traders and investors especially when the increase of the market price is not likely to happen, so a call seller might expect to keep the assets and the premium.
Call option profit
How is it possible to gain profit by buying a call option? For example, if a trader buys a call option at a strike price of $300 expiring three months later in March, the call option will expire worthless if the shares are trading for less than $300 in June. When the call option expires and the strike price of the call is less than the market price, the investor has a possibility to gain immediate profit.
Call options are popular among investors if the prospects of their underlying securities are optimistic, because it opens appealing ways to play the market. An investor or a trader is also able to write a covered call in case he or she already possesses the underlying assets to enhance returns. When the owner has a possibility to sell the securities instruments at a stated price and a set time, it’s called a put option. A put option is contrary to a call option, and it is often used by traders in combination with call options to minimize the risks.
Call auction is an event at which participants' actions help to determine the price for certain securities. Rules at call auctions might vary in details, but there are several key features worth mentioning.
The first important thing is that during a call auction buyers set their highest allowable price and sellers give their lowest acceptable price. It’s also important to note that a certain time period for trading a stock in a call auction is set by the exchange, and the security is illiquid after the given period is finished, and it lasts until the following call. It doesn’t matter if the securities are called for trade at the same time or not. It’s important that the buy and sell orders for each stock are gathered to be executed at the same time. The most crucial advantage of a call auction is that it helps to control price variability.
One more thing to know about call auctions is that orders used there are priced ones, so the prices the participants want to pay in a call auction are announced in advance. So the participants have to pay the price determined immediately during the call auction and so they are unable to control the risks or limit their losses and gains. For instance, a stock XXX’s price is about to be set during a call auction, and several buyers are interested in it. The one who places the maximum number of orders wins, and the stock is sold for the price announced by that buyer, and the others have to pay the same price due to the rules of a call auction.
A call auction is not the same as a continuous market because during a call auction the orders for one type of stock are combined and executed simultaneously together in a many-sided (multilateral) trade for one price. Call auctions are used by a vast majority of stock markets to open and close the day, because the most influential price, the closing price, is typically set during this procedure. This price is critically important for further calculations of prices and it helps to choose the following actions, that’s why the process of establishing it at a call auction is extremely important for markets. In 2018, 90% of stock exchanges used closing call auctions to determine the closing price. Closing call auctions are so widespread because they sometimes make trades easier by softening severe liquidity disturbances. One more notable feature of a call auction is that it’s widely considered to be more persistent to manipulation compared to other possible ways of closing, though nowadays there are scientific studies confirming the possibility of manipulating call actions too.