Fiduciarycall

Key Takeaways

• A fiduciary call is a strategy that involves investing the strike price's present value in a risk-free account while buying a call option.
• This strategy lowers the cost of exercising call options if the investor has the necessary cash.
• It compares to a protective put since both provide a similar profit/loss profile.
• Investors should ensure that funds are properly managed to be available for option exercise if needed.

What Is a Fiduciary Call?

A fiduciary call is an investment strategy where investors combine call options with an interest-bearing account to minimize the costs of exercising the options. This approach allows investors to hold cash in a low-risk account while maintaining the potential to purchase stocks at a set price. It is particularly useful for those who have enough funds to secure a risk-free investment and want to mitigate the expenses associated with options trading.

We'll explore how a fiduciary call functions and its benefits, compare it with other strategies like covered calls and protective puts, and explain essential considerations for maximizing your investment outcomes.

How Fiduciary Calls Work in Trading

Incorporating the word fiduciary in describing this strategy can be a bit misleading, but the concept is very much in line with the spirit of what that word means.

Say an investor wants to buy a certain amount of a stock. They have the funds needed to buy the desired shares; however, rather than use all available funds to buy that stock outright, they purchase calls on the stock. In doing so, they put up a fraction of the money to pay the required premiums compared with the actual shares. The remainder of the funds are then invested in a risk-free, or very low-risk, interest-bearing account (usually money market). The investor is responsible for the due diligence needed to ensure that all arrangements are proper and money will be available to exercise the option if that is the logical outcome.

When the option expires, the value of the interest-bearing account should be enough to cover, or partially defray, the costs of exercising that option (purchasing the shares plus premiums paid), if the option holder chooses to do so. Conversely, if the option holder decides to let the option expire, then they will still have whatever interest they earned to defray the premium costs paid to initiate this strategy. Additionally, their funds are available for the next investment opportunity.

Of course, a fiduciary call requires the investor have the spare cash available to tie up in the risk-free account until the expiration of the option. Most fiduciary calls are based on European options, which are only exercisable at expiration. The strategy is also possible with American options if the investor can reasonably estimate the time to exercise the option. The investor must also match the maturity of the risk-free account with the expected date to exercise the option.

Comparing Fiduciary Calls and Covered Calls

Both a fiduciary call and a covered call are options strategies that limit risk. They both guarantee that if the holder exercises the option, there will be an asset, cash, or shares of the underlying stock, readily available for delivery. There will be no additional market risk involved since neither party will have to engage in open market transactions. However, a fiduciary call is an option purchased by the investor while a covered call is an option sold, or written, by the investor.

A fiduciary call adds a level of comfort for the investor because there will be no uncertainty about funds being available to exercise the option. This is in contrast to a covered call, where the investor already owns the stock. Additionally, a covered call is a profit-making strategy that earns income at the expense of limiting the upside potential for the shares held.

Understanding Fiduciary Calls and Protective Puts

The payoff profiles for a fiduciary call and a protective put are very similar. With a fiduciary call, you start with a risk-free amount and a call option. With a protective put, you start with the actual stock and a put option. If the price of the underlying stock rallies above the strike price, you sell your risk-free asset and buy shares at the strike price with the call. Your profit is the difference between the strike price and market value minus what you paid for the call.

With the put, you already own the shares, so if they rally, you let the put expire worthless. You have the shares valued at the higher market price minus the premium you paid for the put.

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