Call premium

A call premium is the amount an issuer pays above the par value of a bond or preferred stock when it exercises its right to redeem the security early. If a bond is callable at 102, the issuer pays $1,020 for each $1,000 of par value — the extra $20 is the call premium. The term is also used in options trading, where it refers to the price a buyer pays for a call contract.

Issuers call bonds when interest rates fall, because they can refinance the debt at a lower coupon. That is bad news for the bondholder, who loses a high-paying investment and must reinvest the proceeds at current, lower rates — the classic form of reinvestment risk. The call premium exists to soften that blow. Call schedules typically start at the highest premium and step down over time, so a bond might be callable at 103 in the first eligible year, 102 the next, 101 after that, and eventually at par.

In the options context, the call premium is simply the market price of a call option, quoted per share and multiplied by 100 for a standard contract. It consists of intrinsic value (how far in the money the option is) plus time value. The buyer pays it for the right to purchase the underlying stock at the strike price; the writer receives it as income and takes on the obligation to deliver.

Both meanings show up on securities exams. The SIE introduces callable bonds and their call premiums, while the Series 7 and Series 65 test call premiums in the context of callable bonds and yield calculations — a bond bought at a discount and called early produces a higher yield to call than yield to maturity. The Series 7, Series 9, and Series 65 also test option premiums directly in covered call, protective put, and income strategy questions, where premium received or paid determines break-even and maximum gain or loss.