Call money, though a daily element in the financial pages of a newspaper, is not as frequently used or misused as say the Sensex or bullion. The low rate of reference to call money is a good reason why the term should be understood better.

Finance dictionaries describe call money as money put into the money market that can be called in at short notice. And this money at call and short notice appears in the balance-sheet of a bank in the form of an asset. It includes funds lent to discount houses, money brokers, stock exchanges, bullion brokers, corporate customers and other banks.

Such money can be both `at call', where money is repayable on demand, and `short notice money', which implies a notice of 14 days for the repayment of money.

The fact that the money at call and short notice is next to cash in terms of a bank's most liquid assets makes it all the more significant in setting trends in the money market. It's usually an interest-earning secured loan, but the importance of money at call and short notice lies in providing banks with an opportunity to use their surplus funds and to adjust their cash and liquidity requirements.

Looking at it in yet another manner, call money is the cost of a call option. And put money is the cost of a put option. Basically, the cost of an option, whether call or put, is option money. And in traded options, the option money is called the premium.

Before going into the subject further, some facts about an option. It's the right to buy or sell a fixed quantity of a commodity, currency, security, etc, on a particular date at a particular price (also known as the exercise price). An option is different from futures in the sense that the purchaser of an option is not forced to buy or sell at the exercise price and will only do so if it's profitable. The purchaser may even allow the option to lapse, in which case only the initial purchase price of the option (the option money or premium) is lost.

Otherwise, a call option (option to buy) is purchased in the expectation of a rising price; and a put option (option to sell) is bought in the expectation of a falling price or to protect a profit on an investment. The similarity of options with futures is also to be noted. Options, like futures, allow individuals and firms to hedge against the risk of wide fluctuations in prices. They also allow dealers and speculators to gamble for large profits with limited liability. An example of hedging to make the point clear: A manufacturer may contract to sell a large quantity of a product for delivery over the next six months. If the product depends on a raw material that fluctuates in price and if the manufacturer does not have sufficient raw material in stock, an open position will result. This open position can be hedged by buying the raw material required on a futures contract. If the payment is to be made in a foreign currency, the manufacturer's currency needs can be hedged by buying that foreign currency forward or on an option.

Besides hedging, other strategies are employed by professional traders in options. These strategies include purchasing combinations of options that reflect particular expectations or cover several contingencies. Butterfly and straddle are the two most widely used strategies in this context.

The butterfly strategy involves simultaneous purchase and sale of call options at different exercise prices or different expiry dates. A butterfly is most profitable when the price of the underlying security fluctuates within narrow limits.

In contrast to the butterfly, the straddle involves simultaneous purchase of put and call options. It is most profitable when the price of the underlying security is very volatile.

At a Glance

Straddle: Simultaneous purchase of put and call options

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