Who is a good candidate for Theta Growth?

Investors looking for income/cash flow.
Long term equity investors who want less volatility.
Taxable accounts.
Tax exempt accounts.
Foundations with required annual pay-outs.


Who is picking the stocks and managing the options?
Our investment team develops the underlying portfolio by applying the same process that has been in place for over 20 years. The options are also managed by the team. We can forward you their biographies which detail their expertise. How many stocks make up the underlying portfolio? On average, the portfolio will consist of 30 to 40 large cap stocks to produce a diversifi ed portfolio. We buy stocks in round lots of 100 which is necessary in order to sell options against the underlying stock.


Why this type of strategy now?
Long-term equity investors have lowered their return expectations back to historical levels. Because of these lower expectations, the opportunity cost of capping your upside by selling covered calls is decreased. It also means that the 12-18% returns enjoyed by equity investors in the past are no longer as likely. So to get more return without taking more risk can be challenging. Theta Growth, via it’s appreciation and cash flow offers a solid choice.


What sort of cash flow opportunity should I expect?
The total income estimated from option premiums and dividends range from 6-10% annually.


How long have you been doing this?
Capstone fi rst became involved with this type of process in the mid 1970’s. We managed this strategy for a group of insurance companies for which we managed other asset pools. We revived the strategy in September of 2005.


What is your sell discipline?
If a stock fails to meet our buy discipline the position will be sold. The sell discipline for the underlying stocks has been in place for over 20 years via other strategies. Also, if the equity position is not generating adequate levels of income from dividends and the sale of options, it will be reviewed for sale. For options, it would be based on tax consequences ~ how long have we held the position and if it makes sense to roll it forward, let it expire or buy it back … it is option specific.


What are performance expectations and what has performance been?
Since it’s reincarnation in 2005, Theta Growth has generated competitive results relative to what we believe to be the most appropriate barometer for the strategy so far. While there isn’t a perfect proxy for our strategy, we would be happy to discuss with you our thoughts regarding this topic, and our early results. The benchmark that we fi nd to be the most meaningful one the BXM, and the S&P 500.


How is option income taxed?
Option Income is taxed at the individual short-term capital gains rate.

We believe the more ‘sensitive’ issue is short term capital gains on the stocks themselves. We endeavor to produce a low amount of turnover in the underlying portfolio, and therefore minimize capital gains tax on the underlying equities. Because we like the underlying securities, we will tend to roll-up the options at expiration instead of letting the stock get called away.

This is especially true in the first year the account is open. We do everything sensible to push any capital gain into year two so it is taxed as long term. Having said that, there are times that having the stock called away at a profi t in year one is unavoidable, and so there may be short-term capital gain tax implications on the underlying stocks.

However, compared to other buy/write strategies that write nearer the money options on more volatile securities, we should be better able to manage the tax consequences.


Is there any time when we will not have options on a position?
Yes, there will be occasions when certain equities are held uncovered. It may be a function of strike price or a stock specific reason. You can expect to see 70% - 100% of the portfolio covered at all times.

How much will the income fluctuate from month to month?
During the initial investment process, the account will experience a bump in cash infl ow from the establishment of the portfolio. After the portfolio is invested, the cash fl ow will stabilize.

The estimated annualized option and dividend income will fluctuate. We do not expect annual projected total income to change more than 1% in any given month. For clients with monthly cash fl ow requirements we will work with you to meet their cash fl ow needs.

For more detailed information, please request a copy of “Show me the Money” from your sales contact.

Do we use a set formula to determine when options will be written?
We use quantitative modeling with a subjective factor. Stocks are ranked based upon historical and implied volatility. In a 35 stock portfolio, after the positions are ranked, there may be instances where the bottom stocks may not have options written for a period of time. Over time, all stocks will have options written.

In comparison with other covered-call managers:

 1. We do not purely look at option positions and then pick underlying stocks based on the best option volatility.
 2. We are selling calls ‘out of the money’ thereby giving the opportunity for growth potential.
 3. Some managers set durations and “roll” the options annualizing volatility ~ we optimize by doing what the
      market is telling us to do right now.


Are the calls written in the money, out of the money or at the money?
On average, options are typically written 5% out of the money. The options generally have a duration of about 3 - 6 months which adjusts depending on where the best opportunity exists.


For a more aggressive strategy can you sell puts on the portfolio?
Selling puts will be a choice for investors in PHASE II of Theta Growth. Selling puts is allowable in an IRA as long as it is cash secured. It requires a margin agreement.


Do we have aggressive / mid / conservative selections to meet client’s investment objectives?
Currently we only offer the most conservative selection of Theta Growth which includes covered calls. Phase II of Theta Growth will include puts as an additional choice. We also offer “Balanced Theta” which includes an allocation to bonds. The minimum for a “Balanced Theta” account is $250,000. Phase III of Theta Growth is in test phase and includes Puts, calls, ETF’s and other variations.


Haven’t I heard of using a buy/write strategy via a closed end fund?
Yes, this is a common offering!

A drawback to closed-end funds is they can, and often will, trade at a discount to their NAV. Privately managed Theta accounts can be liquidated at anytime at their current market value.

Another drawback is the set dividend of closed-end funds. The way closed-end funds can provide the cash for that dividend is to sell calls. As the market fl uctuates, specifi cally, if the market goes down, these funds are forced to sell calls below their acquisition price. This can ‘whip’ a position out if/when the market rallies. In this sense, the investor is losing on the option trade, and locking in a loss on the underlying equity. This ‘can’ happen in any buy/write program, but Theta seeks to avoid this phenomenon by diversifying the duration of the option writes.


What type of market is ideal for Theta Growth?
A fl at-to-gradually rising market is best for Theta’s strategy. We seek to outperform the overall market in most scenarios. Outperforming during a rapidly rising equity market is not likely. The generation of option premiums help to mitigate (but not eliminate) the downside risk in a declining market, but writing call options will also cap the upside potential during a rising market. However, in a relatively fl at market, Theta seeks to earn option premiums on the equities it holds potentially leading to a higher return than the general market.


The Investment Process
Your client’s account will be invested as quickly as prudently possible taking into consideration the current market opportunities and its interaction with our strategy. The portfolio may be invested quickly, over a few days or it may take longer (a few weeks). Most of the positions will have calls sold (written) very soon after the equities are purchased. Keep in mind that the investment process is methodical and structured and customized for each account based on the behavior of the market, in the best interest of each client. If you have questions about the investment process or our approach to getting the account initially invested, please let us know.

Income Generated
When the account is initially invested, options will be written on most of, or all of the equity positions. This will create a one-time surge in cash to the account as a result of the premium received for selling the option. The options will be structured to expire at different months (staggered duration) and as a result, the income generated in the account will vary depending upon the time that the option position is closed and or the timing of opportunities throughout the year to sell the option again. The options are actively managed and we continuously seek out occasions to buy the option back and sell it again (when appropriate).

Reporting / Statements and Expected Income
Most custodians statements refl ect only a “balance sheet” of current holdings and market values. As such, your internal reports probably do not provide the income information for the account. If you want to know the cash generated from the sale of options or received from dividends, please contact us.

Your statement probably does include dividend yield. Keep in mind this quote is the dividend on the underlying stocks and does not include cash received from option premiums.

The options are accounted for as a liability on your statement and are refl ected as a negative number. As time passes, you will see the negative number change as we move closer to expiration and/or as the price of the stock changes. This cash is what you have pending upon the expiration or closure of the position and is the main engine for generating cash in your Theta Growth account. When the option position expires or is closed out, we look to sell it again (creating another liability and additional cash) so that you have more premium pending.

Withdrawals
The Theta Growth portfolio is designed to decrease equity volatility and generate income. Many investors would like to make withdrawals of the cash they have received from option premiums and dividends. Theta Growth withdrawals are set-up in the same manner as other accounts. If you wish to take a withdrawal, simply notify us of the amount and date. If you know your cash requirements in advance, we can structure the portfolio to keep that cash on hand so that a transaction isn’t necessary to generate the cash required for your withdrawal.

Benchmark and Peer Group
The risk characteristics together with the expected returns make the BXM Index and the S&P 500 Index the most appropriate benchmarks. Please ensure that this is selected for the account so that any information sent to the client is properly illustrated.

Also, the peer group / universe comparison you select should be a Large Cap Core or one as close as possible for comparative purposes.

On Going Communications
Capstone produces quarterly letters that review the market activity and the cash generated in the accounts. If you would like detail of pending or realized cash, please contact us. We are happy to provide an update of the account’s characteristics, statistics and progress at any time.