Concentrated Stock Options Strategy

Transcription

1 APPENDIX D Concentrated Stock Options Strategy This document sets forth the understanding existing between the undersigned account holder(s), (the Client ) and NorthCoast Asset Management LLC (the Advisor ) with respect to Client s concentrated portfolio. Investment Objectives The primary goal of this mandate is the strategic liquidation of Client s concentrated stock position over time. An option overlay relying on Put and Call options will be used in the strategies described below (the Strategy ). Select A or B with liquidation preference A B Option Income and Covered- Call Option Income and Collar Goal is to generate income (and maintain partial upside appreciation potential of position) while lowering overall volatility exposure of the concentrated position by generating an independent investment return stream through the systematic sale of call options against the underlying stock position and / or substitute securities or indices. The potential of the Option Income and Covered call writing strategy does not include protection from downside risk. Goal is to lower the ongoing volatility exposure of the concentrated stock position. This strategy will attempt to apply the income generated through the sale of call options on the concentrated equity position or the substitute securities or indices toward the purchase of put options on the concentrated equity position or the substitute securities or indices on an ongoing basis in an attempt to provide partial protection against large declines in the value of the concentrated stock position. Client s goals for the use of put options (e.g. capping downside exposure at a predetermined loss amount or price target of the underlying security) may entail a collar where the premium income generated from selling Calls equals the amount of premium used to purchase Puts; a net debit where cost of the Puts exceeds income from Calls or a net credit where Call income exceeds Put expense. Client acknowledges and understands that the Client has sole responsibility for initiating and / or discontinuing the Collar feature to be determined in consultation between Client, Advisor and Subadvisor prior to implementation. Concentrated Stock Position Liquidation (Choose one) Automatic Customized in discussion with a NorthCoast advisor One Greenwich Office Park Greenwich, CT info@northcoastam.com p f

2 Investment Guidelines Client understands that there is no guarantee that the objectives stated herein will be realized. Investment Strategy and Risks The Strategy may be based upon proprietary option overlay evaluation, trading and execution techniques developed or licensed by Subadvisor or jointly by Advisor and Subadvisor and identified and monitored by Advisor. Subadvisor will evaluate the liquidity of the option market for the underlying concentrated stock position in consultation with Client and Advisor. Subadvisor will continually monitor all option positions and will look to manage the continued rolling forward of positions at maturity or by sale and repurchase of new positions prior to option maturities, and may rely on its proprietary system. Subadvisor may use proprietary rules and quantitative analysis to determine when to sell Calls and / or purchase Puts. In an attempt to manage the risk of options trades, Subadvisor may employ quantitative probability analysis based upon market volatility information or other options investment techniques. Client also understands and acknowledges that Advisor and Subadvisor s technology, trading systems, software and monitoring tools are critical components of the implementation of the strategy. Client understands and acknowledges that no assurances can be made that these systems and strategies will be successful. Normally, call options sold will be at various "out of the money" (above current price of security) execution or strike prices and different maturities ranging from three to six to nine months. The sale of call options against the underlying stock position generates premium income. This strategy, however, may effectively cap the upside market appreciation of the stock position if its price rises above the option strike price before option maturity. Subadvisor will attempt to manage this risk by writing options at various prices above the security s current price and at various maturities. Client understands and acknowledges that this strategy may result in reduced or limited participation in future appreciation of the concentrated stock position. Client also acknowledges and understands that call options can be assigned, meaning part or all of their underlying stock positions could be sold to generate cash to settle options at maturity resulting in the realization of taxable gains. In such cases, Client consents and directs its Advisor and Subadvisor, as subadvisor, to attempt to purchase for short settlement (1-day) an equivalent amount of shares of the concentrated security to be assigned or sold. Client acknowledges that Subadvisor will elect LIFO accounting with the account custodian whereby the shares presented in the event of assignment or sale, (under normal 2-day settlement) will be the shares most recently purchased, in an attempt to limit the realization of gains from the sale of low basis shares. In some circumstances this could result in additional exposure to the concentrated security entailing greater losses in the event of a price decline. While Subadvisor will attempt to manage all options positions to enhance portfolio returns and protect against assignment and the realization of taxable gains and will also attempt to purchase shares for short settlement as described above in the event of assignment, Client acknowledges their understanding that no assurances can be made that such taxable gains will not occur. One Greenwich Office Park Greenwich, CT info@northcoastam.com p f

3 With respect to certain Client accounts it may be necessary to sell a portion of the underlying stock positions to satisfy expected tax liability, post margin or purchase additional options. The decision to purchase Put options will be solely at the direction of the Client, in consultation with Advisor and Subadvisor, when choosing the Collar strategy. The Collar approach will not necessarily purchase put options on an ongoing basis but selectively with the goal of providing partial protection based upon the risk, cost and duration criteria to be determined upon the implementation of the strategy by the Client and as such may be adjusted going forward. The goal of the Collar is to provide selective, partial protection against large declines in value of the underlying security while attempting to provide a positive net income of call option premium over time versus put option expense. A Collar strategy involves applying the income generated through the sale of call options to pay for the desired level of put protection. Client understands and acknowledges that the relationship between price movements of securities and various put and call options on the same security may vary greatly and that no assurances can be made that the perceived protection to be provided when a put option is purchased will actually result. Put options are often more expensive than comparable call options. As a result, the sale of call options (risking the loss of part of or all of potential price appreciation of the security) to generate premium income often does not result in enough income to pay for the put protection on the entire stock position. In addition, declines in portfolio values may result even when the stock price is stable or rising due to the decline of option values as they decay in value as they approach maturity. Client understands and acknowledges that the Collar Strategy attempts to protect against a portion of large declines for a portion and not all the underlying concentrated stock position however their account may be exposed to the full amount of declines that may be experienced by the concentrated stock position at any given time. Due to the cost, the number of put options purchased are often less than the number of shares owned, resulting in partial protection only. Because the protective puts are typically set at a level around 10% below the underlying market price when they are purchased, protection may not begin to be experienced until a decline of up to 10% or more on the underlying security has been experienced. This protection is targeted to provide limited, three to nine-month protection beyond the 10% down level which is the targeted protection level. Options may expire worthless at maturity or may not perform as expected resulting in losses. Client accounts will typically include: Holding concentrated stock position Sale of Call Options (attempt to generate short term capital gains) against concentrated equity position or substitute security or index. Calls may be repurchased prior to maturity or be allowed to expire at maturity. Purchase of Protective Put Options usually laddered over several expiration dates (attempt to create the limited downside protection) against concentrated equity positions or substitute security or index. Puts may be repurchased prior to maturity or be allowed to expire at maturity. Strategic selling of client concentrated stock position (if elected) Options change the risk profile of the portfolio. The sale of Call options may effectively cap the total upside of the Stock position, entail possible loss of principal in a rising market and can offset gains in the long Stock position. The purchase of Puts entails an expense and can be a drag on portfolio returns. Account considerations One Greenwich Office Park Greenwich, CT info@northcoastam.com p f

4 The Strategy may not be able to be deployed in the same manner in either an IRA or a non-ira account. The Strategy does not use margin to borrow or create any actual portfolio leverage. However, the Strategy does use options and options can be used to create implied leverage. Implied leverage is when you use an option to control more shares than you could control just buying the underlying security. The collar does not use options to create implied leverage. Generally, a margin account is required to trade options. Subadvisor is responsible for the placing of all purchase and sale orders in the Client s segregated account and providing instructions concerning the delivery of cash or securities for the settlement of option trades. Client should consult with their tax advisor to address the income tax consequences of options trading strategies. Client also acknowledges their responsibility to notify Subadvisor and Advisor in writing of any restrictions or prohibited transactions related to the concentrated securities in their account. Additional considerations Client understands that all investments carry with them certain risks, including loss of principal and that Options are versatile instruments which can provide opportunities for generating returns and reducing risk. The Client further understands that these same instruments have unique risks which should be managed by an advisor with experience in trading these instruments. Options involve risk and are not suitable for all investors. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's portfolio. There are no assurances that a portfolio will match or outperform any particular benchmark. Under certain market conditions, it may be difficult or impossible to liquidate a position. Performance related to the Subadvisor Strategies should be viewed in the context of the broad market and general economic conditions prevailing during an evaluation period and in the future. Subadvisor is a Registered Investment Advisor. Registration as an investment advisor does not constitute an endorsement of the firm by securities regulators nor does it indicate that the advisor has attained a particular level of skill or ability. The Client acknowledges receipt of Subadvisor s Form ADV Part 2A. The risk of loss in options trading can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial situation. While an objective of the strategy is to lower volatility exposure of concentrated equity positions, it may involve a greater risk of loss of principal as compared to traditional approaches. The Strategy may include numerous transactions on a monthly, quarterly or annual basis and may result in greater trading related costs as compared to other investment approaches. If necessary, a substitute security or sector index will be identified in consultation with the Client. Client understands that the experience of future price moves of the concentrated stock position compared to a substitute One Greenwich Office Park Greenwich, CT info@northcoastam.com p f

5 security and / or index may vary greatly and there is no assurance that when using a substitute security or index that their objectives will be achieved. To ensure suitability, Clients should familiarize themselves with the Options risk and rewards through review of information provided by the Options Clearing Corporation (OCC) in the booklet Characteristics and Risks of Standardized Options through the following link or by calling OPTIONS, or from the Options Clearing Corporation, One North Wacker Drive, # 500, Chicago, IL, The Client acknowledges receipt of the Characteristics and Risks of Standardized Options booklet. By signing below, the Client has read and fully understands this Investment Policy Statement and agrees that all statements herein accurately reflect the Client s desired investment policy and objectives. Fee Disclosure Client acknowledges that: (a) The costs associated with the purchase and sale of individual securities may be charged to the account by the Custodian; (b) Investment and insurance companies, custodian trust companies, broker dealers, IRA trustees, charitable trust administrators and pension administrators may have additional fees and charges; and (c) The custodian may receive 12b-1 fees, directed commissions and / or administrative, transaction related fees or additional services fees from investments purchased, sold or owned in the account. Client Acknowledgement I/We have reviewed the above Account Investment Objective, Investment Approach and Fee Disclosure. Client Signature: Additional Client Signature: Date: Date: One Greenwich Office Park Greenwich, CT info@northcoastam.com p f