Fiduciary call is a way of collateralizing calling and placing options by investing the exercise price on a fiduciary's appropriate investments. This both reduces the risk of the counterparty with the buyers' option and prevents the writer from increasing his portfolio's leverage. In other words, it is a business strategy that an investor can use if they have the funds to reduce the implicit cost of using a call option. If they have the requisite cash to implement this strategy, it can be cost-effective for the investor (P. Moles, N.Terry 1997, p.218).
The example of the use of Fiduciary Call
An investor would like to purchase a specific amount of stock. They have the funds that they need to buy the stock they want, but instead of using all the funds to buy that stock, they're buying calls from that stock. They put up a fraction of the money to pay the requisite premiums in doing so. The remaining funds are then deposited in an interest-bearing account that is risk-free or very low-risk (usually money). The shareholder is responsible for the due diligence needed to ensure that all plans are right and if that is the logical outcome, the money will be available to exercise the option. When the option takes to end, the interest-bearing account value should be sufficient to cover or partially defray the expense of exercising the option (purchasing the stock plus premiums paid), if the option owner wishes to do so. On the other side, if the option holder decides to allow the option to expire, they will still have some interest earned to offset the premium costs charged to activate the option. Therefore, their investments will be free for the next investment opportunity.
A fiduciary call, of course, allows the investor to have the spare cash at his fingertips in the risk-free account until the option expires. The bulk of fiduciary calls are based on European options, which can only be exercised at expiry. With American options, the strategy is also feasible if the investor can accurately predict the time to exercise the right. To exercise the right, the investor must also align the risk-free account maturity with the expected date(W. L. Pirie 2017, p. 92).
Other strategies of trading
There are two similar strategies(W. L. Pirie 2017, p. 95, 268):
- Covered Call is an alternative strategy, that limits risk. This strategy guarantees that if the owner exercises the right, the underlying stock will be readily available for delivery for an asset, cash, or securities. No increased market risk will be involved as no party will be needed to engage in open market transactions.
- Protective put is another strategy, beginning with the actual stock and a put option with a safe position. If the underlying stock price spikes above the strike price, you sell the risk-free asset and purchase shares with the call at the strike price. The difference between the market value and the strike price is your gain, minus the price of the call.
- Chance D. M., (2011), Essays in Derivatives: Risk-Transfer Tools and Topics Made Easy, John Wiley & Sons, United Kingdom
- Johnson P. M., Hazen T. L., (2004), Derivatives Regulation, Derivatives Regulation, US
- Moles P., Terry N., (1997), The Handbook of International Financial Terms, OUP Oxford, United Kingdom
- Moody E., (2012), Financial Planning Fiduciary Standards under Dodd Fr, ank, Booktango, US
- Pirie W. L., (2017), Derivatives, John Wiley & Sons, United Kingdom
Author: Witold Urjasz