Call auctions are like a big flea market for the buying and selling of options. Call options are those where one predicts the price of an underlying asset (such as a stock) will go up, while a put option is when you predict the price of the asset will go down.
Other types of assets that can be sold as options include bonds, commodities (corn, pork bellies, etc.) or foreign currency.
Traders sell their options at call auctions that take place either on a formal option exchange or over the counter. Here, sellers set the minimum price at which they will sell their options and buyers set a maximum price at which they will buy them. A specific timeframe to either buy the options or let them expire is agreed upon. Options orders are collected throughout the day and at certain times an auction takes place to determine the price.
All this is done electronically and orders are batched together for larger trades and more liquidity (meaning they are easier to sell). Traders interested in a particular security make all their trades at the same time. It's an order-driven system that matches buyers and sellers where an exact trading price is chosen. Sometimes traders can come out ahead in a call auction vs. a continuous auction where trading goes on at any time throughout the day whenever a buy and sell order matches up in price.
Let's say Savvy Investors Inc. puts in a buy order in a call auction with a maximum price to pay of $25.60, but it ends up executing at $25.50. The seller, Win at Options Inc., also makes out on the deal since their lowest price limit was $25.40, but they will now receive $25.50 from the call auction.
Related or Semi-related Video
Finance: What Is a Put Option?83 Views
finance a la shmoop what is a put option? hot potato hot potato
ow ow! yeah remember that game well nobody wanted the potato, poor thing. the
players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]
of work the same way. a put option is the right or option or choice to sell a
stock or a bond at a given price to someone by a certain end date.
all right example time. you bought netflix stock at the IPO a zillion years
ago at $1 a share. that's you know splits adjusted. all right now it's a hundred
bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in
California that would be a tax of something like almost 40 bucks. well the
stock was a hundred but you keep only something like 60. feels totally unfair.
right so you really don't want to sell your stock but you're nervous about the [graph shown]
next few months that Netflix will crater for a while and go down ten
maybe twenty dollars. longer term though you think it'll hit 300. so this is the
perfect setup to maybe look at buying some put options on Netflix. if the stock
goes down your put options go up. with Netflix volatile but at a hundred bucks
a share ,you look up the price of an $80 strike price put option expiring in
December, and you know that's mid-september now .for five bucks a share
you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]
term life insurance. you pay the five dollars a share in the stock goes down
to 82 by mid December, worst of all worlds. well not only did you lose the $5
a share but your stock has lost $18 in value. but had Netflix really cratered
and gone to say $60 a share well you would have exercised your put and sold
your shares at 80 bucks. well those put options you paid $5 for
would be been worth 15 bucks a share. in buying that put option you've [equation shown]
guaranteed that your loss will be no more than a $75 value for your Netflix
position at least for that time period and ignoring taxes. well remember that
options expire after December whatever like the third Friday of the month it's
usually when options expire, you then have no protection and your shares float
along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]
raunchy. yeah well that's naked put options.
that's what they really are people.
Up Next
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
What is a strike price? Strike prices are used in conjunction with options. Calls and puts give investors the right to buy or sell stocks at predet...