One strategy made up of two components or “Baskets” as we call them
We sell short term options against our positions in Basket I. Short term to maximize the speed at which the options value drops. Price decay is quickest as options get near their expiration date. Our goal is to generate ½% per month or more. Probability based strategy. Profitable 66-80% of the time.
This is a rules based strategy. It is tightly managed to take profits and prevent large losses. Options are never held to expiration and our rules (contingent orders are placed when initial trade occurs) never allow a put or call to go “in the money” We have managed this way for over 14 years. We have managed through many wild gyrating markets. Basket II enables us to balance our portfolio, keep it market neutral and has earned approximately half of our returns over the years.
Our rules call for adjustments in the trade at specific points on the price line. We will take profits on one side of the original trade and sell a new put or call, in effect keeping our sweet spot over the market range. If the market continues in the same direction, we will buy back the other side of the trade and sell a new put or call at the appropriate strike. These adjustments has the effect of moving our probability of profit up to 80% from 66%. In this example, we buy back all, or a portion of the original call and sell a new call at a lower strike, bringing in more premium.
In the last 10 years the S&P 500 has been down 4 times. Clients did not have to make up 30 to 50% losses as they did with traditional balanced and stock market only investments
Where do you think 17 Yearswe‟re headed? History Shows that the market typically moves in cycles. In the past 105 years, there 17 Years 11 Years have been three bull markets and three bear markets. The chart shows that we may have entered a bear market. 25 Years 5 Years Bull 18 Years Bear 1906-1924 1925- 1930-1954 1955-1965 1966-1982 1983-1999 2000-? 1929Value of the Dow Jones Industrial Average for 105 Years (1906-2011)
What do investors want? Not to lose money Hope to get or stay rich Banish fear of being poor Leave money to kids and or spend money in retirement
How will you get there? Adding new managers that will enhance your current mix of investments and supplement them during an economic cycle when traditional investments do not work.
How will you get there? Typically, investors have used three strategies to get there: 1. Asset allocation 2. Market timing 3. Buy and hold
Diversification works… Asset Class Examples Using Vanguard Mutual Funds Timeline goes from top of the Tech Bubble through the bear market of 2000-2002 and recovery to the peak in October 2007S&P500Pacific IndexREIT IndexSmall CapTotal Bond IndexEuropean IndexEmerging Markets
until it doesn‟t… Asset Class Examples Using Vanguard Mutual Funds After October 2007, equities marched in relative unison. Bonds offered the only significant diversification. SMARToptionS&P500Pacific IndexREIT IndexSmall CapTotal Bond IndexEuropean IndexEmerging Markets
Find Non-Correlated Assets Correlation Sphere Traditional investment assets correlate to “1” in this area Hedged Equity
Market timing • The idea is to move money to bonds and cash when the market is going to go down OR • Tactically move between asset classes during different cycles in the economy • Timing the market involves calling it right twice, not just once, and thats nearly impossible
Market timing• Most investors tend to let the competing emotions of fear and greed dictate their investment decisions• This leads to the tendency to invest after a significant increase in prices and sell during down periods, the opposite of buying low and selling high.
Market timing• This phenomenon has been widely documented, included in a 2003 Dalbar Study*• It shows that the average investor stayed invested in equity funds for less than 3 years, buying when stocks went up and selling when the going got tough*2003 Dalbar, Inc., “Quantitative Analysis of Investment Behavior”.
Market timingThe end result was that investors earned an average of 2.57% from 1984 to 2003, ahair below inflation of 3.14%, and far shortof the 12.2% annual gain on the S&P 500 for the same period
Market timing The record on professionals timing the market is just as abysmal. • The Hulbert Financial Digest* has tracked what would have happened if every year an investor put his money into the prior year‟s top performing market timing newsletter. • Over 21 years the result would have been an annualized loss of 31.4 percent a year. • In the real world, that‟s equivalent to investing $10,000 in January 1981 and finding that all you have left at the end of 2002 is $2.32.*Mark Hulbert, Hulbert Financial Digest, http://www.fundadvice.com/FEhtml/PsychHurdles/0304b.html
Market timingThe Bottom Line: It is very difficult to time the market successfully!
Buy and Hold Investors American Airlines $36.13 $37.05 1980 to January 12, 2012 $20.87 $13.62 $8 $2.34$4.44 $0.32
Buy and Hold Investors 1996Eastman Kodak 1987 $801962 to January 12, 2012 $68 1972 $66 2009 $2.96 1/2012 $0.52
Buy and Hold InvestorsMicrosoft2000 to January 12, 2012 April 3, 2000 $32.53 January 23, 2012 $25.70
Buy and Hold Investors If you bought and held a 60/40 If you bought the S&P 500 portfolio* in 2000 and held it through (stocks/bonds), what it would 2011 have done… OR You would be about even e.g. 2008 30%*Lipper Diversified Growth and Income Index
Are there other financialtools I can use to protectand grow wealth?
How to Collar a Black SwanTHE STRIKING PRICE | SATURDAY, JANUARY 8, 2011By STEVEN M. SEARSUsing options to manage the risk of a downturnmay be a good idea.“…pension funds and other institutionalinvestors …can no longer rely solely onmacro-economic analysis to adjust portfolios.They have to be cognizant of tail risk and riskmanagement on an ongoing basis. The ideaof tail risk, essentially that the unexpected willhappen from time to time, is one of the keytraits of the modern stock market”.
What are other Institutionalinvestors saying? Joann Hill, ProShares Head of Investment Strategies (2010 IMN Superbowl of Indexing keynote presentation). “alternative strategies that include options add value to a portfolio and outperform traditional strategies in risk reduction” James E. Keohane, Healthcare of Ontario Pension Plan Senior Vice- President (2010 IMN Superbowl of Indexing presentation). “portfolio managers that do not use options can not adequately protect against market risk”.
Options are: Contracts to either BUY or SELL a specific investment at a specific price The purchase price of an option is called the PREMIUM – you pay for this if you exercise your option or not.
Options:The contracts establish a specific price called theSTRIKE PRICE at which the contract may beexercisedOPTIONS have a shelf life –Also called an expiration date,which is the latest date you can“exercise” you option or close out your position
CALL = BuyThe purchase of a call option gives the owner theright but not the obligation to BUY 100 shares of theunderlying security at the STRIKE price on or beforethe expiration date.The buyer has the right but not the obligationto BUY the shares.The seller of the option does have the obligationto sell the shares to the buyer.
PUT = SellConversely, the purchase of a put optiongives the owner the right but not theobligation to SELL 100 shares of theunderlying security at the STRIKEprice at anytime before the expirationdate.In this case the seller of the put is required tobuy the security at the strike price at thebuyer‟s request.
Buyers of options Including both puts and calls spend money. They pay the premium.Seller of options Including both puts and calls collect money. They collect the premium.
PUT OptionsPut options are usually purchased as protectionagainst falling stock prices. You pay the premiumupfront so that if the underlying stock falls belowthe strike price, your potential loss is limited.This protective put works like an insurance policy.
PUT OptionsIf you buy a put option on the S&P 500 (SPY):You pay some money upfront, and you have the right to sell SPYat a certain price, no matter how much SPY declines. If SPY goesbelow your strike price, the value of you put will increase. Themore the SPY falls, the higher your put will be worth.You can sell the put for a profit anytime before the expiration date.If the SPY stays above the strike price, you still can sell the putanytime before the expiration date, but for less than what you paid.
The Covered CallA strategy in which an investor sells or “writes” a call optioncontract while at the same time owning an equivalentnumber of shares of the underlying stock or index fund, likeSPY.The stock or index fund is generally held in the samebrokerage account from which the investor writes thecall, and fully collateralizes, or "covers," the obligationconveyed by writing a call option contract.This strategy is the most basic and most widely usedstrategy combining the flexibility of listed options with stockownership.
The Covered Call• If you sell a covered call on the SPY, you collect some money upfront, and you have the obligation to deliver your shares of SPY if it hits the strike price.• If SPY stays below the strike price, you get to keep the premium you collected.• If SPY approaches the strike price, instead of waiting for your shares of SPY to be “called away” you can buy the calls back and close the position.
PUT OptionsIf you sell a put option on the SPY:You collect the premium immediately adding cash to youaccount, and you have the obligation to buy shares of SPY ifit hits the strike price.If SPY stays above the strike price, you get to keep thepremium you collectedIf SPY approaches the strike price, instead of being forced tobuy SPY at that price, you can buy the puts back and closeout the position.
Are options risky?Not any more risky than buying astock is risky.It‟s the investment strategy that cansignificantly lower risks, not the optionsthemselves.When correctly applied and activelymanaged they can be tailored for specificpurposes and market conditions.
Are options risky?When incorrectly applied or leftunmanaged, these strategies can exposeinvestors to unacceptable losses.In the past when these strategies failed, theymade headlines in the news.Options ended up with the blameinstead of the investment strategy.
The Options ClearingCorporation (OCC) ► OCC is a participant in every options transaction, serving as the intermediary between buyers and sellers. ► You do not deal with any person on the other side of the transaction, you are dealing with the OCC ► OCC issues, guarantees and clears all option trades placed on the U.S. options exchanges. ► Ensures that all of the rules involved in the sales transactions will be followed and that each side will perform as promised.
The use of exchange-listedoptions has been growingat a phenomenal rate. 500% In the last ten years trading volume has increased by nearly 500%, with more than 3.8 billion contracts traded in 2010.* *2010 Options Industry Council Benchmark Study
Why should you have optionsin your portfolio? 1.Generate income 2.Hedging 3.Diversification 4.Locking in profits
Basket IConsists of: • S&P 500 exchange traded fund • a put option to minimize riskThe option portion of Basket I is specifically designed to limit a portfolio‟sexposure to falling markets. The option component is an investmentsimilar to an insurance policy on your house. The deductible for thispolicy (amount you pay for protection) is specifically chosen to limit (noteliminate) losses.If Market is Put is
Basket I 100% of client money Hedge / Downside Equity Protection (85-90% of client money) (10-15% of client money)S&P 500 Exchange Traded Fund Long Put Option: Bought at or near SPY the money – sized to give you defined risk of 7-10% maximum downside.
Basket IBy investing in a broad-based index fund such as SPY, itautomatically reduces company/ sector risk throughdiversification across multiple companies and even markets(e.g.US/International).Buying and holding the index ETF also eliminates futileattempts in market timing and/or predicting future values ofindividual stocks.This strategy is possible because protection from significantdeclines does not come from prophesy but from the Basket Ihedge.
Basket II We sell out of the money Puts and Calls against our positions in Basket I (Brings cash into the account)1. Sell Put on SPY 2. Sell Call on SPY
Basket IIWhen puts and calls are sold, they generatepremium or „income‟ that is added to your account.This independent income generating component ofthe strategy generates income to the account in allmarket conditions.
Basket IIThis income also helps to offset the cost of the hedge usedin Basket I. It incorporates multiple specified adjustment andliquidation points to minimize risk and maximize thefrequency and size of monthly returns.These adjustment and liquidation points were extensivelyback-tested and then proven through implementation overthe past 14 years.Basket II has been quantitatively designed in type, size, &frequency to provide market-neutral returns.
Basket II – Selling out of the moneyPuts and Calls against our positions in Basket I 1. Sell a put 2. Sell a call Sweet spot over theIf the market moves down market. Take profits on If the market moves uptoward put strike, we have both the put and call if toward call strike, we a stop order to buy back market remains within have a stop order to the put here sweet spot buy back the call here Put in the $ Call in the $ 1. Put strike S&P 500 current 2. Call strike price market price price
Basket II Adjustments If the market movesIf the market moves down down toward puttoward put strike, we have strike, we will take adjustment points that Sweet spot over the profits on the original enable us to stay in the market moves with call and sell a new trade and increase the the market call which brings in probability of success to more premium over 80% Original Put New Call Original Call S&P 500 S&P 500 closed for strike price new price original price profit
SMARToption‟s – 2 componentsBasket I - 100% of a client‟s portfolio is invested in Basket I. 85-90% isinvested in SPY equity shares and 10-15% is invested in a hedge through along-term option on SPY.
Basket II is an independent income generating componentof the strategy which has been quantitatively designed intype, size, & frequency to provide market-neutral returns.* *Based on past performance
The Key to SMARToption‟s Success Upside Capture has 100% averaged 70% of Bear the S&P 500 70% returns in bull markets -5%Downside Capturehas averaged 5% of the BullS&P 500 returns in bearmarkets -100%
SMARToption captures substantialupside in bull markets Market Cycles and minimizes losses SMARToption vs S&P 500* in bear markets! SMARToption* S&P 500 Bull 1 49.23% 71.17%Bear 1 24.41% -37.61% Bull 2 53.61% 82.85%Bear 2 -3.60% -37.00% Bull 3 44.50% 48.97%*Since inception, 1997, gross of feesImportant Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
Cumulative Value vs. Market Bull and Bear Market Cumulative Values SMARToption* S&P 500 SMARToption vs S&P 500* Bull 1 $149,232 $171,169Bear 1 $185,660 $106,792 Bull 2 $285,192 $195,269Bear 2 $274,925 $123,019 Bull 3 $397,156 $183,254*Since inception, 1997, gross of feesImportant Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
The Key to SMARToption‟s Success Prevent large losses! Down Years for the S&P 500* From 2000- 12.97% 2002, hedging 12.22% protected the 8.42% downside and -3.6% actually provided a profit! -9.10% -11.89% In 2008, when S&P 500 lost 37%, we -22.10% were down only 3.6% before fees! -37.00%*Since inception, 1997, gross of feesImportant Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
Reduces Risk Increases Returns Risk vs. Return 1997- 2011 Annualized Return Risk – Standard DeviationImportant Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
Client in SMARToption since 1997 *Net of fees Aggregate Growth vs. Indices* 4.5 1997 – 2011 4.0 3.5 SMARToption 3.0 S&P 500 2.5 2.0 1.5 1.0 12/97 12/99 12/01 12/03 12/05 12/07 12/09Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
Take the Good with the badIf you are in the market and nothedged when the market drops40%, it’s a lifestyle change!
Client in SMARToptionsince 2003 Aggregate Growth vs. Indices* *Net of fees 2003 – 2011 2.6 2.4 SMARToption 2.2 S&P 500 2.0 1.8 1.6 1.4 1.2 1.0 1/04 1/05 1/06 1/07 1/08 1/09 1/10 1/11Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
The proof is in the performance SMARToption vs S&P 500 Cumulative Returns 1997 – 2011 SMARToption (Gross of Fees) S&P 500 297% 83%Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
The proof is in the performance Growth of $100,000 Cumulative Returns 1997 – 2011 SMARToption (Gross of Fees) S&P 500 $397,156 $183,254Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can beno assurance, and clients should not assume, that future performance will be comparable to past performance.
Are a big deal!In the past, investors had great difficulty obtaining meaningfulcomparisons of accurate investment performance data.Making apples-to-apples comparisons of investmentperformance was problematic,and the existence of country-specificguidelines for performance presentationfurther complicated matters.
Are a big deal!There was a need for a practitioner-driven set of ethicalprinciples and a standardized, industry-wide approach tocalculating and reporting investment results.The foundation for the GIPS standardswas first established in 1987.To develop one globally acceptedset of standards, the GIPScommittee began work in 1995 to getthem formally endorsed
Are a big deal!After an extensive period of public comment, the AIMR Boardof Governors (now known as the CFA Institute) formallyendorsed the GIPS standards in February 1999.Since their introduction, the GIPS standards have gatheredmomentum with investment management firms worldwideadopting these voluntary, ethical standards for calculatingand presenting historical investment performance.Organizations in 34 countries sponsor and promote thestandards.
Are a big deal!• GIPS compliant firms voluntarily go beyond legal reporting requirements to demonstrate a commitment to open, honest, and ethical practices.• To claim compliance, an investment firm must demonstrate adherence to comprehensive and rigorous rules governing input data, calculation methodology, composite construction, disclosures, and presentation and reporting.• GIPS compliant firms must have their data audited and verified by a qualified third party firm.
Are a big deal!Investments that adhere to GIPS® should assureinvestors that the firms’ investment performance is complete and fairly presented.
FeesSMARToption will have a SET FEE SCHEDULE!Fees will be deducted quarterly for a total of 2.25% annually.The FEE SCHEDULE is not-negotiable and cannot be altered.You will not see any other fees taken out of your account NO transaction fees NO ticket charges NO trading costs How can we do this?
Wrap fee structure A wrap fee structure is where both: ● Asset management fees for advisory services ● Transaction fees for execution services are wrapped into a single fee charged to the client. In a Wrap Fee arrangement, a client’s costs are the same regardless of the number of transactions in an account.
Total Expense Structure The underlying vehicle is an S&P 500 ETF, which has a very low expense ratio of 0.0945%. TOTAL ANNUAL FEE: 2.25% + 0.0945 = 2.3445%
It‟s all about transparency ► With fee-based money management you know what you are paying for upfront. ► Your advisor’s interest is in-line with yours. The better your investments performs the higher the fee they will receive. ► When compared to other fee structures for comparable products, this fee schedule is quite reasonable.
Expense Ratios► According to the Investment Company Institute (ICI) the average expense ratio for a mutual fund that is actively managed is 1.45%.► This includes fees paid to the manager of the fund, administrative costs, marketing and distribution services.► The expense ratio is not deducted from your account, rather the investment return you receive is already net of the fees.► Plus on top of that you will also pay your advisor a fee. Typically 1%-2%.► Assuming 1.5% (advisory fee) + 1.45% (average expense ratio mutual fund) this brings the total cost of owning a mutual fund to about 3.0%, not to mention trading and transaction fees that may apply!
This Putnam Fund has an expense ratio of 1.58%+ 1.50% Management fee + Other transaction costs $$$
Liquidity ► The underlying holdings in the account consist of an ETF (SPY) and options (puts and calls), all of which are highly-traded, marketable securities. Therefore, the strategy is 100% liquid at all times as we could simply sell these securities if needed at any time. ► To optimize the strategy, we would strongly discourage you from taking funds out of the SMARToption Model, so that you can receive the full benefit of the model‟s performance.
Liquidity ► SMARToption is positioned as the core “growth” strategy and so short-term liquidity should be addressed elsewhere in your financial plan.
Technology Advantage One of the most sophisticated and highest performing strategies in the industry, SMARToption requires advanced technology to be able to implement across thousands of accounts. ► We have developed a proprietary electronic system which facilitates implementation, monitoring, and adjustment of the strategy. ►By specifically designing our interface consistent with our strategy, we have dramatically simplified implementation and management activities such as trading, new account investment, reporting, etc.
Operations Trading Systems ● Broker-Specific Trading and Order Management Systems ● Proprietary/Custom Trader Software Monitoring/Coverage ● Continuous oversight /monitoring during trading hours ● Multiple traders monitoring positions and executions (redundancy) ● Automated email/phone notifications on market price, adjustment & liquidation points Back Office/Reporting ● Captools (GIPS® Compliant) performance software