What is a Callable Security?
A callable security gives the issuer or a third party the right but not the obligation to repurchase the security at a specific price after a certain time.
How Does a Callable Security Work?
Let's assume you own 100 shares of Company XYZ callable common stock. If the stock is callable (that is, the issuer can repurchase the stock) at 105% of market price and the shares are trading at $100 per share, then Company XYZ could force you to sell your shares back at $105 per share. The strike price (the price at which the security could be bought) on callable common stock often is calculated according to a schedule provided by the issuer at the time the shares are sold.
Why Does a Callable Security Matter?
Because the issuer can buy back the securities, the strike-price premium is meant to compensate the holder for some or all of this risk. Regulators usually require all transaction confirmations involving callable securities to disclose that the security is callable.
It is important to note that the prices of callable securities are affected by the price of the underlying security. For example, if a stock is callable at $100 and the shares are trading very close to that (say, at $99), the likelihood that the stock will be called soon is much higher than if the stock were trading at $89 (further away from the strike price .) As a result, because investors know that the issuer will probably call the shares if they trade above $100, the stock's price appreciation is effectively capped at $100 per share.
Certified Experts