a bank typically issues a letter of guarantee on behalf of a client who has entered into a contract to buy goods from a supplier the letter contractually guarantees to pay the recipient even if the client should default to get a letter of guarantee the customer will need to apply for it like a loan if the bank is comfortable with the risk it will back the customer with the letter for an annual fee letters of guarantee are used in importing and exporting commercial contracts margin trades major purchases real estate investments mergers and acquisitions and other significant financial transactions 
a letter of guarantee may also be issued by a bank on behalf of a call writer when assuring another party that the writer owns the underlying asset and that the bank will deliver the underlying securities should the call be exercised call writers will frequently use a letter of guarantee when the underlying asset of a call option is not held in their brokerage account understanding letters of guaranteeletters of guarantee are often used when one party in a transaction is uncertain that the other party can meet their financial obligation this is especially common when buying costly equipment or other property however a letter of guarantee may not cover the whole value of the property at issue for example a letter of guarantee in a bond issue may promise either interest or principal repayment but not both the bank will negotiate how much it will cover for their client banks charge an annual fee for this service typically a percentage of how much the bank would owe should the client default letters of guarantee are used in a wide variety of business situations these include contracting and construction financing from a financial institution or declarations during export and import processes letter of guarantee for a call writerbecause many institutional investors maintain investment accounts at custodian banks rather than at broker dealers brokers will accept a letter of guarantee for call writers with short options as a replacement for holding cash or securities the letter of guarantee must be in a form that the exchange and potentially the options clearing corporation accept the issuing bank agrees to give the broker the underlying securities if the call writer s account is assigned to obtain a letter of guarantee a customer must apply for it much like a loan example of a letter of guaranteeassume company xyz is buying a large piece of customized equipment for 1 million the equipment supplier will need to fabricate it and it won t be ready for several months the buyer doesn t want to pay right now but the supplier also doesn t want to spend time and resources building the equipment without guaranteeing that the buyer will pay for it and has the resources to do so the company can go to its bank and get a letter of guarantee this is all the supplier should need to go forward since the bank guarantees it will pay should the buyer not do so for another example suppose a call writer has 10 short contracts on the stock in company xyz which equals 1000 shares if the stock price rises the short positions will lose money the loss could theoretically be infinite since there is no cap on how far a stock can rise but if the call writer owns 1000 shares of a stock then the risk is mitigated this is a covered call to short the stock in the first place the writer may have had to produce a letter of guarantee that they own the stock in another account if the broker thought an uncovered short call was too risky 