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.
Advantages of Fiduciary Call
Fiduciary calls are calls made by a fiduciary, typically a financial advisor or other professional, to review and discuss the financial assets of a client. Here are some of the advantages of fiduciary calls:
- A fiduciary call can help a client make sound decisions about their investments. Because a fiduciary is legally obligated to act in the client's best interest, they can provide objective advice on how to handle their financial assets.
- Fiduciary calls can also help clients identify and address any potential risks or problems with their investments. By having an experienced professional review their financial portfolio, clients can be sure that they are taking the necessary steps to protect their investments.
- Fiduciary calls can also provide clients with a more comprehensive view of their financial situation. By discussing their financial goals and objectives, a fiduciary can help the client create a plan for achieving those goals. This can help them make better decisions about how to manage their money and reach their financial goals.
- Finally, fiduciary calls can provide peace of mind to clients who may be worried about their financial situation. Having a knowledgeable professional review their assets and provide objective advice can help them feel more confident in their financial decisions.
Limitations of Fiduciary Call
Fiduciary calls are used to protect the interests of investors in a company. However, there are certain limitations to fiduciary calls that need to be considered when using this financial management tool. These limitations include:
- Lack of Flexibility: Fiduciary calls are typically fixed investments with predetermined terms and conditions. This lack of flexibility can limit the potential returns of the investment, as well as the ability to respond quickly to changing market conditions.
- Lack of Liquidity: Fiduciary calls can be difficult to sell or transfer. This lack of liquidity can make them less attractive to potential investors.
- Cost: Fiduciary calls can be expensive to set up and manage, which can make them less attractive to potential investors.
- Limited Scope: Fiduciary calls are limited in scope and typically only cover a specific set of investments. This can make it difficult to diversify a portfolio and make decisions based on a broad range of economic conditions.
The following approaches are closely related to the Fiduciary Call:
- Environmental, Social and Governance (ESG) investing involves the consideration of environmental, social, and corporate governance (ESG) criteria to generate long-term returns and positive societal impact.
- Socially Responsible Investing (SRI) is an investment strategy that considers both financial return and social and environmental good. SRI often includes screening investments to avoid companies involved in certain industries, such as gambling, alcohol, or tobacco, as well as investing in companies that have a positive impact on society, such as those involved in renewable energy.
- Impact Investing is the practice of investing in companies, organizations, and funds with the aim of generating measurable social and environmental impact alongside a financial return.
- Stewardship Investing is an approach to investing that emphasizes the need for investors to be active in their role as owners of companies and to engage with the management of those companies to ensure that the long-term interests of the company are met.
In summary, Fiduciary Call is closely related to other approaches such as ESG investing, SRI, Impact Investing and Stewardship Investing, all of which are focused on generating both financial returns and positive social and environmental impacts.
- 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