Fiduciary Call

A fiduciary call is a cost-effective strategy designed to limit the costs associated with exercising a call option. When the investor purchases a call option, he or she also invests the present value of the strike price in a risk-free interest-bearing account. When the investment matures, the value of the account will be enough to cover the costs of exercising the option (purchasing the shares), if the holder chooses to do so.

Calling this strategy fiduciary is a little trickery but the concept is very much in line with the spirit of what a fiduciary does. By having enough money on account, earning interest in a risk-free, or very low-risk way, the investor is assured that all arrangements are proper and money will be available to exercise the option.

And if the option holder decides to let the option expire, then they will still have whatever interest they earned on the account plus the principal available for the next investment.

Of course, a fiduciary call requires the investor to have the spare cash available to tie up in the risk-free account until 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. He or she must also match the maturity of the risk-free account with the expected date to exercise the option.

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 go into the open market to transact.

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 that funds will be available to exercises the option. In contrast, with a covered call, the investor already owns the stock. This is a profit-making strategy that earns income at the expense of limiting upside potential for the shares held.

The payoff profile 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.