A call is a type of option. It is generally understood to be the right, but not the obligation, to buy an asset at a certain price (the strike) at or before a certain time.

Wow, that's a mouthful. So, what does it mean? It means that we can buy an asset - for instance, a stock, or a bond, for cheap if it goes up. If the stock goes down, I simply don't buy. This has three consequences:

  1. If the stock goes up, I make money. Hence, it's the same as virtually owning some stock.
  2. If the stock goes down, the (potential) profit for the option will go down. The good news here is that I can never be obliged to buy the stock, so, at worst, my option is worthless. Because options only cost a fraction of really buying the stock, my loss may be limited.
  3. A call always has a positive value. Because the potential gains become smaller as it gets closer to expiry, a call continuously loses a bit of value.

There are a few other, subtle points worth mentioning about buying calls. Firstly, if you own shares, you might get a dividend. Owners of calls don't get these dividends. This may be partially priced into the call. Sometimes, it's a good idea to exercise the call - buy the shares - before the dividend, so you get the shares and the dividend. Whether or not this is a good idea is a question fit for an expert.

The flip side of this is that investing in a call only requires a fraction of the cash of buying the stock. This means the rest can be put in a bank and get you interest. This is also priced into a call. market makers are smart like that.

There are two important variables in trading calls: The strike and the duration. A higher strike means I need to pay more to eventually buy the share. To compensate, the call is cheaper, meaning you need less money or can buy more. High strikes are "bets" that the stock will go up a lot (a takeover comes to mind), while lower strikes are more like "discount investments" with limited risk.

If the duration of the option is longer, it has more time to rise. This has a particularly strong effect on calls with high strikes: it may be unlikely that a share rallies 10% a month, but 10% a year is certainly possible. These options are also more expensive.

Selling a call can be done if you don't think a stock will go up. This is tricky; you might lose a LOT if it does go up - in fact, your potential loss is completely unlimited. However, what is often done is buying shares and then selling the call, in particular one that has a strike above the current price of the share. In this construction, you get dividend and money for selling the call. Furthermore, if you go up, you first make on the stock, and then sell it for the agreed price, so you make money. If the stock goes down, you do lose, but the money received for the call makes up for this. This so-called covered call - strategy is a pretty good one for private investors.

In conclusion, a call is an option that gives the right to buy shares at a certain price before a certain time. By buying a call, it is possible to profit from an increase in the share price without buying the share. If done properly, this makes it possible to invest with less, or rather a different, risk.




WARNING: CONTAINS MATHS


A call is a type of forward in which the purchaser (also the buyer, the party whom is long, the party who owns a long position) has the right, but not the obligation, to purchase an asset for a predetermined price at a predetermined date in the future. Buying a call is essentially buying a long forward which you have the right (or option) to not execute the contract upon maturity. The agreed upon price is referred to as the strike price which is always priced at the time at which the call is purchased. In essence: a call is a bet that the underlying asset will increase in price by the maturity date of the forward, allowing the buyer to purchase the asset at the strike price and then immediately sell at the spot price for a measurable profit.


t = time, generally noted in years, or fractions thereof
X = the strike price, agreed upon at t=0
C = the price of the call, reflecting the premium due to secure the right to cancel the contract
Q = Quantity of asset to be delivered at t=T, agreed to at t=0
St = Price of the asset at t=t
e = The natural number, e
r = The interest rate for the contract period specified at t=0
max = the mathematical function by which the greatest of presented arguments (separated by commas) is selected


Future Position Payoff Profit
Long max(0,(St - X)) * Q { max(0,(St - X)) * Q } - { C * (1 + r ) * Q }
Short - { max(0,(St - X)) * Q } { C * (1 + r ) * Q } - { max(0,(St - X)) * Q }


The table of payoffs and profits illustrates how the buyer, or long position, has the option of executing the call and will do so only if the spot price of the underlying asset is greater than the strike price. If this is true, the buyer wins the bet, and the seller (the writer, the owner of the short position, the party whom is short) loses. Options are a zero-sum game. In truth, the wager of a call is somewhat mitigated by the premium reflected in the price of the call, but this only decreases the gain/loss of the two parties and does not affect the zero-sum nature of the transaction.

Graphically...

P/O ($)
|
|
|           ¦     /
|           ¦    /
|           ¦   /
|           ¦  /
|           ¦ /
+-----------¦/--------- St
|
|
|
|

   THE PAYOFF OF A LONG CALL



 ($)
|
|
|
|           ¦     /
|           ¦    /
|           ¦   /
+-----------¦--/----------- St
|           ¦ /
|           ¦/
|-----------¦
|
|

   THE PROFIT OF A LONG CALL



P/O ($)
|
|
|           ¦    
|           ¦   
|           ¦  
|           ¦ 
+-----------¦\--------- St
|           ¦ \
|           ¦  \
|           ¦   \
|           ¦    \
|

   THE PAYOFF OF A SHORT CALL



 ($)
|
|
|           ¦    
|           ¦   
|-----------¦\  
|           ¦ \ 
+-----------¦--\--------- St
|           ¦   \
|           ¦    \
|           ¦     \
|           ¦      \
|
   THE PROFIT OF A SHORT CALL

The final piece to the call puzzle lies in the valuation of the premium to be charged by the writer of the call. Generally the price of the call C will be increased by two factors: the increasing duration of the call, and the decreasing delta between the initial asset price and the agreed upon strike price. There are also premium factors which consider the type of call you intend to purchase. A European style call may only be executed or cancelled on its maturity date, whereas an American style call may be executed on any day between the contract date and maturity date. Since it is more likely that the spot price could exceed the strike price over a range of dates, when compared to one specific date, the premium on an American call must always exceed that of a similarly struck European call. Luckily, there are also two formulae of rather advanced arithmatic which can help solve the valuation of a call. Because calls abide by Put-Call Parity, we are able to solve for the price of the premium C just as soon as we have accounted for a "basis of time" in our calculations.


interest compounding Valuation method
Discrete Binomial Option Pricing
Continuous Black-Scholes



McDonald, Robert L. "Derivatives Markets". 2006. Pearson Education, Inc.

Call (?), v. i. [imp.& p. p. Called (?); p. r. & vb. n. Calling] [OE. callen, AS. ceallin; akin to Icel & Sw. kalla, Dan. kalde, D. kallen to talk, prate, Gr. to speak, sing, Skr. gar to praise. Cf. Garrulous.]

1.

To command or request to come or be present; to summon; as, to call a servant.

Call hither Clifford; bid him come amain
Shak.

2.

To summon to the discharge of a particular duty; to designate for an office, or employment, especially of a religious character; -- often used of a divine summons; as, to be called to the ministry; sometimes, to invite; as, to call a minister to be the pastor of a church.

Paul . . . called to be an apostle
Rom. i. 1.

The Holy Ghost said, Separate me Barnabas and Saul for the work whereunto I have called them.
Acts xiii. 2.

3.

To invite or command to meet; to convoke; -- often with together; as, the President called Congress together; to appoint and summon; as, to call a meeting of the Board of Aldermen.

Now call we our high court of Parliament.
Shak.

4.

To give name to; to name; to address, or speak of, by a specifed name.

If you would but call me Rosalind.
Shak.

And God called the light Day, and the darkness he called Night.
Gen. i. 5.

5.

To regard or characterize as of a certain kind; to denominate; to designate.

What God hath cleansed, that call not thou common.
Acts x. 15.

6.

To state, or estimate, approximately or loosely; to characterize without strict regard to fact; as, they call the distance ten miles; he called it a full day's work.

[The] army is called seven hundred thousand men.
Brougham.

7.

To show or disclose the class, character, or nationality of.

[Obs.]

This speech calls him Spaniard.
Beau. & Fl.

8.

To utter in a loud or distinct voice; -- often with off; as, to call, or call off, the items of an account; to call the roll of a military company.

No parish clerk who calls the psalm so clear.
Gay.

9.

To invoke; to appeal to.

I call God for a witness.
2 Cor. i. 23 [Rev. Ver. ]

10.

To rouse from sleep; to awaken.

If thou canst awake by four o' the clock.
I prithee call me. Sleep hath seized me wholly.
Shak.

To call a bond, to give notice that the amount of the bond will be paid. -- To call a party Law, to cry aloud his name in open court, and command him to come in and perform some duty requiring his presence at the time on pain of what may befall him. -- To call back, to revoke or retract; to recall; to summon back. -- To call down, to pray for, as blessing or curses. -- To call forth, to bring or summon to action; as, to call forth all the faculties of the mind. -- To call in, (a) To collect; as, to call in debts or money; ar to withdraw from cirulation; as, to call in uncurrent coin. (b) To summon to one's side; to invite to come together; as, to call in neighbors. -- To call (any one) names, to apply contemptuous names (to any one). -- To call off, to summon away; to divert; as, to call off the attention; to call off workmen from their employment. -- To call out. (a) To summon to fight; to challenge. (b) To summon into service; as, to call out the militia. -- To call over, to recite separate particulars in order, as a roll of names. -- To call to account, to demand explanation of. -- To call to mind, to recollect; to revive in memory. -- To call to order, to request to come to order; as: (a) A public meeting, when opening it for business. (b) A person, when he is transgressing the rules of debate. -- To call to the bar, to admit to practice in courts of law. -- To call up. (a) To bring into view or recollection; as to call up the image of deceased friend. (b) To bring into action or discussion; to demand the consideration of; as, to call up a bill before a legislative body.

Syn. -- To name; denominate; invite; bid; summon; convoke; assemble; collect; exhort; warn; proclaim; invoke; appeal to; designate. To Call, Convoke, Summon. Call is the generic term; as, to call a public meeting. To convoke is to require the assembling of some organized body of men by an act of authority; as, the king convoked Parliament. To summon is to require attendance by an act more or less stringent anthority; as, to summon a witness.

 

© Webster 1913.


Call, v. i.

1.

To speak in loud voice; to cry out; to address by name; -- sometimes with to.

You must call to the nurse.
Shak.

The angel of God called to Hagar.
Gen. xxi. 17.

2.

To make a demand, requirement, or request.

They called for rooms, and he showed them one.
Bunyan.

3.

To make a brief visit; also, to stop at some place designated, as for orders.

He ordered her to call at the house once a week.
Temple.

To call for (a) To demand; to require; as, a crime calls for punishment; a survey, grant, or deed calls for the metes and bounds, or the quantity of land, etc., which it describes. (b) To give an order for; to request. "Whenever the coach stopped, the sailor called for more ale." Marryat. -- To call on, To call upon, (a) To make a short visit to; as, call on a friend. (b) To appeal to; to invite; to request earnestly; as, to call upon a person to make a speech. (c) To solicit payment, or make a demand, of a debt. (d) To invoke or play to; to worship; as, to call upon God. -- To call out To call or utter loudly; to brawl.

 

© Webster 1913.


Call (?), n.

1.

The act of calling; -- usually with the voice, but often otherwise, as by signs, the sound of some instrument, or by writing; a summons; an entreaty; an invitation; as, a call for help; the bugle's call.

"Call of the trumpet."

Shak.

I rose as at thy call, but found thee not.
Milton.

2.

A signal, as on a drum, bugle, trumpet, or pipe, to summon soldiers or sailors to duty.

3. Eccl.

An invitation to take charge of or serve a church as its pastor.

4.

A requirement or appeal arising from the circumstances of the case; a moral requirement or appeal.

Dependence is a perpetual call upon hummanity.
Addison.

Running into danger without any call of duty.
Macaulay.

5.

A divine vocation or summons.

St. Paul himself believed he did well, and that he had a call to it, when he persecuted the Christians.
Locke.

6.

Vocation; employment. [In this sense, calling is generally used.]

7.

A short visit; as, to make a call on a neighbor; also, the daily coming of a tradesman to solicit orders.

The baker's punctual call.
Cowper.

8. Hunting

A note blown on the horn to encourage the hounds.

9. Naut.

A whistle or pipe, used by the boatswain and his mate, to summon the sailors to duty.

10. Fowling

The cry of a bird; also a noise or cry in imitation of a bird; or a pipe to call birds by imitating their note or cry.

11. Amer. LandLaw

A reference to, or statement of, an object, course, distance, or other matter of description in a survey or grant reguiring or calling for a carresponding object, etc., on the land.

12.

The privilege to demand the delivery of stock, grain, or any commodity, at a fixed, price, at or within a certain time agreed on.

[Brokers' Cant]

13.

See Assessment, 4.

At call, ∨ On call, liable to be demanded at any moment without previous notice; as money on deposit. -- Call bird, a bird taught to allure others into a snare. -- Call boy (a) A boy who calls the actors in a theater; a boy who transmits the orders of the captain of a vessel to the engineer, helmsman, etc. (b) A waiting boy who answers a call, or cames at the ringing of a bell; a bell boy. -- Call note, the note naturally used by the male bird to call the female. It is artifically applied by birdcatchers as a decoy. Latham. -- Call of the house Legislative Bodies, a calling over the names of members, to discover who is absent, or for other purposes; a calling of names with a view to obtaining the ayes and noes from the persons named. -- Call to the bar, admission to practice in the courts.

 

© Webster 1913.

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