What Is a Buyer's Call?
A buyer’s call is an agreement between a buyer and seller in which the purchase of a commodity is at a specific price above a futures contract that is for the same grade and quantity.
The agreement gives the buyer the option to fix the commodity price by either purchasing a futures contract from the seller or indicating to the seller the price and date at which the transaction could occur in the future. Another name for this agreement is known as a call sale.
- A buyer's call is a contract where a purchaser obtains the right to obtain some commodity or financial product at a predetermined price, often greater than the current price, at some point in the future.
- A buyer's call requires an initial outlay of funds that gives purchases the option to consummate the deal at a later date, similar in some respects to putting down a deposit that may be forfeited if the purchase never occurs.
- In financial markets, call options fulfill many of the functions of a buyer's call.
Understanding Buyer's Calls
A buyer’s call occurs when a buyer needs a commodity that the seller has in stock. However, the buyer does not require the delivery of the physical commodity immediately. Instead, both parties agree to transfer at a later date. A commodity futures or forward contract agreed to by both the parties, binds the agreement. When the buyer's call is initiated, the purchaser will advance some funds to the seller to guarantee the right to the future purchase, similar in some ways to putting down a deposit. These funds that bind the deal are essentially payment for the option's premium.
A buyer's call may be used in place of buying a commodity outright on the spot market. The spot market for financial instruments and commodities is one where trades are effected and delivered immediately, or on the spot.
A buyer's call transaction's strike price is typically placed at a level above the spot or futures market price. The buyer satisfies their need for the asset at a locked price, and the seller receives the futures contract which would replenish his inventory at a later date. Both the quantity required and the quality exchanged of the commodity must match.
In options trading, there are two types of contracts.
- A call allows the owner, who is long the call, to buy an underlying good at a specified exercise strike price within a specified period. It requires the seller, who is short the call, to deliver the underlying product when the call holder exercises the call. A call option increases in value if the price of the underlying commodity rises.
- A put permits the owner to sell the underlying commodity at a specified exercise strike price within a specified period. A put requires the seller, who is short the put, to purchase the underlying good when the put owner exercises their right to sell that good at the strike price. A put increases in value if the price of the underlying commodity falls.
Example of a Buyer’s Call
A buyer who needs 10 barrels of sweet crude oil immediately could purchase them on the spot market for $50 per barrel. However, if that same buyer does not require the oil for another six months, a buyer’s call would allow them to enter into a contract with an oil company that has the oil for a specific price and a future delivery date.
By entering into the call, the buyer would either offer to buy a six-month future contract from the oil company in exchange for the barrels of oil or offer to buy 10 barrels of oil at some point in the future at a fixed market price. In this scenario, the oil company would be able to make a profit from the buyer’s purchase while still obtaining their required amount of oil inventory, six months into the future.