Fiduciary Calls vs Protective Put Example
Assuming MSFT is trading at $30 per share, its November $30 Call Option is trading at $0.80 and November $30 Put Option is trading at $0.80.
Assuming you own 100 MSFT shares at $30 per share. You buy 1 contract of MSFT Nov30Put for $0.80.
Total cost of position = ($30 x 100) + ($0.8 x 100) = $3080.
You buy one contract of MSFT Nov30Call for $0.80.
Total cost of position = ($0.80 x 100) = $80.
The protective put position in the example above costs $3,080 to put on. However, there is a cheaper way to get exactly the same potential payoff profile and that is by using a Fiduciary Call.
A Fiduciary Call is simply the buying of enough At The Money call options to represent the total amount of shares that would be bought. In this case, a Fiduciary Call requires the buying of only 1 contract of MSFT Nov30Call for $80 (Assume Nov30Call = $0.80).
Through buying a Fiduciary Call, the rest of the fund that would have been otherwise committed to a protective put position can be reinvested in a risk free instrument, thus returning more overall profit than a protective put position. In essence, a protective put creates a synthetic call position.
|Fiduciary Call||Protective Put|
|Profit If MSFT $50||$1920*||$1920**|
|Loss If MSFT $10||$80`||$80``|
Clearly, using a Fiduciary Call returns the exact same profit, has the exact same loss but utilises only a small fraction of the price of a protective put position through the principle of Put Call Parity. This also means that a stock combined with a put option creates a synthetic call option. In order for a Fiduciary Call to return the exact same profit/loss profile, leverage must be controlled such that no additional MSFT shares or options are bought using the remaining fund. The remaining fund should be held in a fiduciary account which returns a risk free interest rate in order to safely return an additional profit to the overall fund. Hence the term "Fiduciary". This is also what makes the famous Stock Replacement Strategy possible.
However, having both the put options and call options at the money at the same time and with perfect put call parity is a rarity. Most of the time, the stock would be several cents or dollars in the money on one side and out of the money on the other side. In this case, the Fiduciary Call may not return the same profile as the Protective Put if near the money options (NTM) are used in both cases.
NTM Fiduciary Calls vs NTM Protective Put Example
Assuming MSFT is trading at $30.50 per share, its November $30 Call Option, which is slightly in the money, is trading at $0.90 and November $30 Put Option, which is slightly out of the money, is trading at $0.70.
Assuming you own 100 MSFT shares at $30.50 per share. You buy 1 contract of MSFT Nov30Put for $0.70.
Total cost of position = ($30.50 x 100) + ($0.7 x 100) = $3120.
You buy one contract of MSFT Nov30Call for $0.90.
Total cost of position = ($0.90 x 100) = $90.
The resulting profit and loss at $50 and $10 becomes:
|Fiduciary Call||Protective Put|
|Profit If MSFT $50||$1910*||$1880**|
|Loss If MSFT $10||$90`||$120``|
In this case, using a Fiduciary Call is clearly more beneficial than a Protective Put as the Fiduciary Call requires lesser capital, returns a higher profit and a lower loss. As such, options traders should make careful calculation to see what works best in each specific situation.