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Fidelity Options Fund
How the Fidelity Options Fund works
The Fidelity Options Fund invests in short-term (less than 1 year) cash investments, which will earn interest.
Much like a property investor uses their own house as security to leverage and buy more houses, the money is then used as security to sell option contracts to various banks. These option contracts are based on movements in the 10-year government bond rate over a 30-day period. The bank pays Fidelity a premium for taking the risk that the 10-year rate moves more than 25 basis points (0.25%) in the next month. It is analogous to an insurance contract, where Fidelity would receive a premium but must pay out if a particular event occurs.
If the 10-year rate moves less than 25 basis points (bp) up or down, Fidelity pocket the premium, and do not pay out on maturity of the option. The premium averages 10 to 15bp per month.
If the 10-year rate moves more than 25bp then Fidelity must pay the bank. In the last six years, the rate has varied more than 25bp only one month in four. In these cases the payout will depend on the severity of the change.
The client's return is then a combination of:
Interest earned on the short-term cash deposits, plus
The options premiums paid to us by the banks (less any payout).
Each option contract pays only a small premium, but because Fidelity issues ten (five on the upside, ie should the rate rise by 0.25%, and five on the downside,) Fidelity can multiply the premium by ten.