The term “Call” carries distinct meanings in the realms of finance and business. This entry explores the various definitions and applications of a “Call,” particularly focusing on call options and call auctions. Other related concepts in the financial and trading sectors will also be discussed.
Call Options
Call options are a type of financial contract that grants the option holder the right, but not the obligation, to buy a specified amount of an underlying asset at a predetermined price (strike price) within a specified time frame.
Characteristics of Call Options
- Underlying Asset: The financial security upon which the call option is based (e.g., stocks, bonds).
- Strike Price: The fixed price at which the option holder can purchase the underlying asset.
- Expiration Date: The date by when the call option must be exercised.
- Premium: The price paid for purchasing the call option.
Mathematically, the price of a call option can be modeled using the Black-Scholes formula:
where:
- \(C\) is the call option price,
- \(S_0\) is the current stock price,
- \(K\) is the strike price,
- \(t\) is the time to expiration,
- \(r\) is the risk-free interest rate,
- \(\Phi\) is the cumulative distribution function of the standard normal distribution,
- \(d_1 = \frac{\ln(S_0 / K) + (r + \sigma^2 / 2)t}{\sigma \sqrt{t}}\),
- \(d_2 = d_1 - \sigma \sqrt{t}\),
- \(\sigma\) is the volatility of the stock.
Example of Call Option
Suppose an investor purchases a call option to buy 100 shares of Company XYZ at a strike price of $50, with an expiration date three months from now. The premium paid is $5 per share.
- If the market price rises to $60 before expiration, the option holder can exercise the right to purchase at $50, profiting $10 per share minus the premium.
- If the market price remains below $50, the investor may let the option expire, losing only the premium paid.
Call Auctions
A call auction is a process through which assets are traded at specific times by matching buy and sell orders at a single price. This is commonly used to determine opening and closing prices in stock markets.
Mechanism of Call Auctions
- Order Matching: Orders are collected over a period and matched at a single equilibrium price where supply meets demand.
- Equilibrium Price: The price that maximizes the number of shares traded.
- Double Auction: Both buyers and sellers submit their orders, contrasting with continuous trading where transactions occur in real-time.
Example of Call Auction
In a call auction, bids are submitted before the auction begins. If the highest buying price is $55 and the lowest selling price is $52, the equilibrium price might be $53. All transactions during the auction period happen at this price.
Other Meanings in Business and Finance
- Callable Bonds: Bonds that can be redeemed by the issuer before maturity.
- Margin Call: A broker’s demand for an investor to deposit additional money or securities.
Related Terms
- Put Option: Grants the holder the right to sell the asset at a predetermined price.
- Strike Price: The fixed price an option holder can buy or sell an underlying asset.
- Expiration Date: The deadline for exercising an option contract.
FAQs
What is the difference between a call option and a put option?
Why are call auctions used in stock markets?
References
- Black, Fischer, and Myron Scholes. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 1973.
- Hull, John C. Options, Futures, and Other Derivatives. Pearson, 2014.
Summary
The term “Call” in finance can refer to several different concepts including call options, call auctions, callable bonds, and margin calls. Understanding these different contexts is crucial for comprehending the complexities of financial markets and investment strategies.
