Call (Options and Auctions) – Definition

Cite this article as:"Call (Options and Auctions) – Definition," in The Business Professor, updated July 30, 2019, last accessed June 2, 2020, https://thebusinessprofessor.com/lesson/call-options-and-auctions-definition/.

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Call Auction – Definition

A call either refers to a call auction or a call option. A call option is an agreement or a contract that gives a person the right but not an obligation to purchase a portion of an underlying asset at a specified time and price. In this trading method, a timeframe is set in which the underlying assets must be purchased at the specified price.

A call auction is a trading method in which a seller sets a minimum price to sell a security and the buyers set or fix the maximum price to buy the security. The security is offered to the highest bidder afterwards.

Key Takeaways

  • A call refers to either a call option or a call auction.
  • A call option offers the holder the right to buy an option or underlying asset at a specified time and price.
  • A call auction entails a seller fixing a minimum satisfactory price to sell a stock while the buyers or participants fix a maximum acceptable price at which the stock can be purchased.
  • A call auction is also a call market.
  • A call option is a formal trading arrangement, like an over-the-counter trading.

A Little More What is a Call (Option or Auction)

Generally, a call auction is a trading approach used when trading a security or an underlying asset on an exchange. A call auction can also mean a call market. In this method, prices are determined by trading activities at a particular time. The seller sets a minimum satisfactory price at which he wishes to sell the commodity and the buyers set the maximum price to buy the commodity.

A call option can be likened to over-the-counter transaction. Securities products are formally traded at a specific time and a specified time frame. Investment banks or institutional lenders sometimes use this method to demand repayment for a loan.

Call Option

Different securities such as bonds, stocks, currencies and other debt instruments can be traded in a call option. In this trading arrangement, the can owner can exercise the right to buy an underlying security at a fixed time and specific timeframe. This is however not an obligation, it is just a right.

The seller of the option or security is often referred to as the writer. Holders of calls enjoy many benefits for holding this right. For instance, if a security has a lower stake price on the call date, the holder of the call can purchase the option, thereby benefiting from a reduced price. The current market value often determine the stake price for options.

A put option is different from a call option, this right is enjoyed by a seller. The seller has the right to sell a security at a specific price and specified time frame but not obligated.

Call Auction

When there is a limited number of stocks to be offered in an exchange, a call auction can be used as the trading strategy. The time that this type of trade will take place is also set. Buyers of stocks in this arrangement, set a maximum acceptable price at which they can buy the stocks while the seller also set a minimum satisfactory  price to sell the stock. In a trade of this nature, all interested buyers and the seller must be present at the designated venue at the appropriate time.

Participants that are present at a call auction state the price that are willing to pay for an offered stock, the statisfied price is arrived at during the auction by the seller. In most cases, the highest bidder takes the asset.

Reference for “Call”

Academic research on “Call”

On jumps in common stock prices and their impact on call option pricingBall, C. A., & Torous, W. N. (1985). On jumps in common stock prices and their impact on call option pricing. The Journal of Finance40(1), 155-173. The Black‐Scholes call option pricing model exhibits systematic empirical biases. The Merton call option pricing model, which explicitly admits jumps in the underlying security return process, may potentially eliminate these biases. We provide statistical evidence consistent with the existence of lognormally distributed jumps in a majority of the daily returns of a sample of NYSE listed common stocks. However, we find no operationally significant differences between the Black‐Scholes and Merton model prices of the call options written on the sampled common stocks.

Anticipated information releases reflected in call option pricesPatell, J. M., & Wolfson, M. A. (1979). Anticipated information releases reflected in call option prices. Journal of accounting and economics1(2), 117-140. This study captures the ex ante information content of a financial reporting event (the annual earnings announcement) by examining the behavior of call option prices on dates leading up to and passing through the disclosure date. This approach differs from most previous empirical security price research which has been ex post in nature. The hypothesis that investors anticipate that the future release of annual earnings numbers will affect security prices is empirically confirmed. In particular, systematic changes in variance rates implied by the Black-Scholes option pricing model are demonstrated.

Further results on the constant elasticity of variance call option pricing modelEmanuel, D. C., & MacBeth, J. D. (1982). Further results on the constant elasticity of variance call option pricing model. Journal of Financial and Quantitative Analysis17(4), 533-554. The Black-Scholes [4] call option model is a member of the class of constant elasticity of variance call option models proposed by Cox [6]. While the Black-Scholes model assumes that the volatility or instantaneous variance of return is constant through time, the other members of the class allow the volatility to change with the stock price. This property is of interest because empirical evidence suggests that returns to common stock are heteroscedastic and also that volatilities, implied from the Black-Scholes model and market prices of call options, are not constant.

Call option valuation for discrete normal mixturesRitchey, R. J. (1990). Call option valuation for discrete normal mixtures. Journal of Financial Research13(4), 285-296. In this study a mixture call option pricing model is derived to examine the impact of non‐normal underlying returns densities. Observed fat‐tailed and skewed distributions are assumed to be the result of independent Gaussian processes with nonstationary parameters, modeled by discrete k‐component independent normal mixtures. The mixture model provides an exact solution with intuitive appeal using weighted sums of Black‐Scholes (B‐S) solutions. Simulating returns densities representative of equity securities, significant mispricing by B‐S is found in low‐priced at‐ and out‐of‐the‐money near‐term options. The lower the variance and the higher the leptokurtosis and positive skewness of the underlying returns, the more pronounced is this mispricing. Values of in‐the‐money options and options with several weeks or more to expiration are closely approximated by B‐S.

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