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Concentrated Income Strategy
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John has worked as a manager
for XYZ Corp for 18 years and in the process has acquired nearly
35,000 shares of the company’s stock. His goal is to continue
holding the stock until it reaches a more favorable sell price.
John has become frustrated watching the position rise and fall
with the market and wants to evaluate alternatives to enhance the
return on the idle stock position.
How It Works
The objective of the Concentrated Income Strategy (CIS) is to
enhance the income potential of concentrated stock positions
through a professionally managed options strategy. This is
achieved by selling call options on a concentrated stock position
in exchange for upfront cash premiums. Our sophisticated model
helps clients determine the appropriate number of options to sell
while investing in the call option that provides the best value.
The portfolio structure maintains the integrity of the investor’s
ultimate sell objectives.
The CIS seeks to achieve the following:
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Provide income through the
receipt of option premiums
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Allow the investor to
continue receiving dividends and voting rights
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Provides upside
appreciation to the target price
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Sell the optimal call that
statistically adds the most value
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Hedge a stock decline
through the option income
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Establish discipline needed
to execute a sell strategy
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Succeed in its objectives
regardless of which direction the stock moves
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Work successfully for those
wanting to sell and those not looking to sell their stock at
all
The following chart graphically
displays the outcome of the strategy based on changes in the
desired target price. As the average target price increases,
income decreases.
(click
here to enlarge this graph)
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For Those
Looking to Sell…
Watts Gwilliam & Company’s CIS
model offers structure, discipline, and sophistication to
concentrated stock portfolios. Central to the success of the
strategy is our commitment to each client’s individual needs and
goals. For some this means working with a Watts Gwilliam & Co.
financial advisor to establish a sell strategy. In such cases,
target prices are based on the client’s desired exit prices as
determined through an individual consultation. Our model’s
flexibility allows the client to “average” out of the stock at
various prices and does not force the investor to choose a
“one-price-sells-all” target.
After a consultation with a Watts Gwilliam & Co.
representative, John decided to sell 10,000 shares at $30, 10,000
shares at $32.50 and 10,000 at $35. A customized CIS was put in
place, giving John an average sales price of $32.50, 25% above the
current market price of ABC’s stock. John received immediate
income of $13,800 while the model projects total annual income of
$22,000. The chart below summarize the outcome of John’s strategy:
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For those NOT looking to
sell their stock…
In some cases there are valid
reasons for not selling a concentrated stock position. Often
investors ultimately prefer to hold onto the stock and not sell at
all. Our models include mechanisms designed to help investors
maintain the position. This allows clients to use their target
prices to speculate rather than sell their stock.
While meeting with Watts Gwilliam & Co., John mentions that he
isn’t committed to selling his ABC stock. John anticipates that
ABC Co won’t appreciate over 35% this year. Watts Gwilliam & Co.
customizes a strategy using the CIS model designed to enhance the
yield of the otherwise idle stock. The strategy is put in place
and John immediately realizes an income yield of $8,500, or
roughly 1%. It is estimated that his annual yield will be around
$14,000, if the stock doesn’t increase more than 35%. While the
strategy is in place John continues to receive dividends on the
stock.
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Is the CIS right for you?
The Concentrated Income Strategy should be considered by
investors:
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With a concentrated stock
position that meets the Watts Gwilliam & Co. minimum
requirements (lesser of 10,000 shares or $500,000 market
value)
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Desiring enhanced income
yield off the concentrated stock position
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Seeking to either sell all
or a portion of the position, or speculating on the stock
remaining under a target price
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Commonly Asked Questions
Q: Is it possible to prevent low basis stock from being
called away?
A: The CIS uses listed options to execute its strategy. Listed
options are American style options, which means that it is
possible for shares to be exercised prior to the maturity of the
option. This rarely happens. If the client desires to retain their
shares and is exercised and called to deliver stock, Watts
Gwilliam & Co. will buy stock in the open marketplace to deliver
against the exercise of the option. This is a simultaneous
transaction that is normally cash flow neutral.
Q: I currently have a margin balance against my shares. Are
they still eligible for the program?
A: Yes. In fact, many clients use the CIS income to hedge
the cost of margin interest.
Q: Can I terminate the strategy before the options expire?
A: Yes. However, doing this may require closing option positions
at a loss. There is a chance that this loss could exceed the
upfront income that was earned at the onset of the strategy.
Q: Is this strategy available in retirement accounts?
A: Yes. Selling covered call options is an approved for
most retirement accounts, including IRA accounts.
Q: Can the strategy be used on my unexercised employee stock
options?
A: Yes. However, the following terms must be met:
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The client must have
options that are vested, in-the-money, and expire in no less
than one year
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The client must understand
the added risks of investing in naked options
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The client must
collateralize the program’s short option position with
sufficient assets
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Watts Gwilliam & Co. may
request duplicate quarterly statements detailing the status of
your employee stock options.
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Attend a local Seminar
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For a customized proposal click here
* Examples, charts, and
assumptions used on this website are for illustrative purposes
only. Actual results may very, and could result in either higher
or lower returns than illustrated above.
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