Call

Definition

A call, in the financial context, generally refers to a type of option contract that provides its owner the right, but not the obligation, to buy a specified quantity of an underlying asset at a predetermined price (called the strike price) before or at the option’s expiration date. There are two types of calls, American and European, with American-style calls being exercisable anytime before expiration, and European-style calls only exercisable at expiration. These financial instruments are typically used for speculation, hedging, or income generation by selling covered calls.

Phonetic

The phonetic pronunciation of the keyword “Call” is /kɔl/.

Key Takeaways

1. A call option is a contract that grants the holder the right, but not the duty, to purchase the underlying asset on or before a certain date at a stated price.
2. The striking price, the expiration date, the volatility of the underlying asset, and the risk-free interest rate are some of the variables that affect the cost of a call option.
3. Call options can be utilized for many different things, such as speculation, hedging, and generating revenue.

Importance

The finance term “call” holds significant importance in the realm of business and finance, as it represents a contractual agreement that grants the buyer an opportunity to purchase a particular financial asset, typically stocks, at a predetermined price, known as the “strike price,” within a stipulated time frame. This instrument empowers investors to mitigate risks, secure potential profits, and capitalize on favorable market conditions, such as rising stock prices. Call options provide financial flexibility by offering a hedge against adverse market movements and enabling strategic investment decisions without necessitating the immediate purchase of the underlying asset. Consequently, they play a crucial role in fostering efficient market operations, enhancing liquidity, and contributing to the dynamic financial ecosystem.

Explanation

In the realm of finance and business, “call” serves as a strategic financial instrument designed to empower investors, particularly when it comes to dealing with option contracts or buying specific assets. The purpose of a call option is to provide the investor with the opportunity to buy a certain amount of an underlying asset, such as stocks, at a predetermined price, known as the “strike price,” within a specified period. What makes call options so appealing is that they allow investors to capitalize on the potential appreciation of an asset’s value while simultaneously eliminating the need for an immediate, significant upfront investment. This is advantageous as it helps investors mitigate risks and harness financial growth without the need to fully commit to purchasing the underlying asset. The utilization of call options is especially prevalent among investors who anticipate a positive upswing in market trends or the value of the assets they are eyeing. By purchasing a call option, investors can lock in the option to buy the assets at the strike price, granting them the chance to attain those assets at a potentially lower cost before their market value soars. If the market value of the asset does indeed rise above the strike price, the call option holder can exercise the option, buy the asset at the lower price, and either retain or sell the asset for a profit. In cases where the market value does not surpass the strike price, the call option simply expires, which results in a moderately smaller financial loss compared to the direct purchase of the asset itself.

Examples

1. Callable Bonds: In the world of finance, a callable bond is a debt security that allows the issuer to redeem the bond before its maturity date. This is done at a specified call price, which is often higher than the face value of the bond. Companies generally issue callable bonds when they anticipate declining interest rates, so they can refinance their debt at lower rates in the future. For instance, let’s say Company A issues a 10-year callable bond with a 4% interest rate. If interest rates in the market drop to 2% after 5 years, the company can call back the bond and issue new bonds at the lower interest rate, significantly reducing their borrowing costs. 2. Stock Options: Another real-world example of call options comes from the world of stock trading. A call option is a financial contract that gives the option holder the right, but not the obligation, to purchase a specific stock at a predetermined price, known as the strike price, within a specified period. Suppose an investor holds a call option for Company B’s stock with a strike price of $50 and an expiration date of 6 months. If Company B’s stock price rises to $60 within that period, the investor can use their call option to purchase the stock at the lower $50 price, giving them an instant profit. 3. Real Estate Call Options: Call options are also used in the real estate industry. Real estate developers may acquire a call option on a property, allowing them to buy it at a specified price during a specified period. This gives developers time to obtain permits or complete inspections without having to fully commit to the purchase upfront. For example, a developer may obtain a call option on a waterfront property at a price of $1 million, with the option expiring in two years. If the developer secures permits and funding during this time, they can exercise the option and purchase the property at the agreed-upon price, regardless of any potential increase in property value.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Call Option
• Strike Price
• Expiration Date
• Option Premium
• Option Writer

Sources for More Information

• Investopedia – Call Option
• Nasdaq – Call Option
• Fidelity
• Daily Forex