Exponent Investment Management

Benoît Poliquin, CFP, CFA – President and Lead Portfolio Manager

www.ex-ponent.com

Option Strategies for your Portfolio

RAISON D’ÊTRE

Issues facing investors todayLow interest rates have increased the need for

income. Need more capital for same level of income.

Markets have been volatile and have not offered dependable capital growth opportunities.

Makes for difficult long term decisions.

Underlying global economy does not provide for stellar environment for companies.

What will provide better returns for investors in the future?

THE SOLUTION IS…

Owning Quality AssetsStock Market are volatile.

Expectations and economic events are unpredictable.

≠Your spending needs are certain.

Most investors sell low and buy high. Humans are pre-wired to seek out the safety of

crowds… Performance chasing

Owning a businessImagine you owned a business:

Where the brand name was establishedProven ManagementProfitableDividends increased every year

Would you invest?

What if…Every day, someone can quote you a price on

this business.

Would you always own it?

Would you be worried if were offered 30% less than what you paid? Would you be offended or exited?

For Example: Johnson & Johnson• At first glance, stock

price is disappointing…$10 in growth in 10 years

• But better than the market

• JNJ +22%• S7P 11%

• However• Dividend from $0.18

in Q2 01 to $.57 in Q2 11 = 3X

• Earnings Per Share• 2001=$1.75 /

2010=4.78

• Quality Matters• Boring…but profitable!

What if..You invested in 20-30 companies with these

characteristics.You were disciplined on purchase price & and

your sale price.You get a bid every dayTake advantage of irrational investors

Always earning dividend income.GrowingTax efficient (Canadian Corporations)Passive…your money working for you

YES, BUT CAN I MAKE MORE?

OPTION STRATEGIES CAN HELP…

Options Basics:An equity option is the right but not the

obligation to Buy (Sell) at a specified price (strike price) by a certain a date.

They are listed just like a stock…trade them in a similar fashion.

Option Prices are influenced by: Underlying share price. Time until expiration of the option. Volatility (how much the price varies over time). Interest Rates. Dividends.

Option Types:A Call Option allows the holder/buyer to

purchase the shares at a future price by a specified expiration date.You can buy a call optionYou can sell or write a call option

A Put Option allows the holder/buyer to sell the shares at a future price by a specified expiration date.You can buy a put optionYou can sell or write a put option

PUTTING IT ALL TOGETHER

Step One: QualityAssemble a portfolio of companies domiciled

in Canada and abroad with the following characteristics:

An ability, a history and a policy of paying ever growing dividends to shareholders

Operate in profitable industries Sound management

Step 2: ResearchDetermine the fair market value:

Based on historical valuation (ie: P/E ratios, BV ratios) In relation to the company itself In relation to the broad equity market (TSX, S/P

500,etc.) In relation to the price of money/interest rates

Determine entry points:Based on fair market value researchTechnical analysis

Step 3: Option ResearchDetermine appropriate strike prices for call

to be sold.& select ideal date of expiration

Determine appropriate strike prices for put writing.Ensure sufficient cash component for the

underlying commitment to purchaseSelect ideal date of expiration

LIVE EXAMPLES

Example #1: JNJ (ignoring transaction costs)

Stock Price = $64.08 Assume stock is purchase at this price; Sell call (Oct 22/2011 expiry) for $0.64 & Strike= $67.50 Your net investment is $64.08-0.64= $63.44 Probability of being exercised ≈ 31%

If JNJ trades for more than $67.50, call option in the money If exercised, investor sells @ strike, for a profit of $4.06 ($67.50-

$64.08+$0.64) or 6.4% Profit of 6.4% in 49 days Investor can repeat 7 times in the year

If JNJ trades below $67.50, investor keeps premium Repeat process upon expiration of call option

RamificationsIf investor has many choices;

Can buy back call (at a loss) and keep JNJKeep profit and…

Investor can sell put against proceeds at a lower priceInvestor can invest in another company and repeat the

covered call exercise.

Benefits:Higher cash flow = consistent returnDisciplined sell and purchase prices

But Upside is capped to $4.09 for 49 days

JNJ conclusion- Securitized PutsInvestor was “called away” from JNJ and sold

at $67.50Investor would like to reinvest in JNJ @ 62.50

Can wait in cash until this price is reached in the market

Investor can could sell $65 put and securitize the commitment to purchase with cash Sell put $65 and collect ≈ $3.25 Commitment to buy JNJ @ $65 in 50 days is set

aside If JNJ trades down to $65, put should get exercised

at net cost is $61.75 to invest in JNJ If JNJ stays above, $65, simply repeat with new put

option

Example #2: RY (ignoring transaction costs)

Stock Price = $48.93 Assume stock is purchase at this price; Sell call (Oct 22/2011 exp) for $.35 & Strike= $55 Your net investment is $48.93-.35= $48.58 Probability of being exercised ≈ 14%

If RY trades for more than $55, call option in the money If exercised, investor sells @ strike, for a profit of $6.42 ($55-$48.93+

$0.35) or 13% Profit of 13% in 49 days Investor can repeat 7 times in the year

If RY trades below $55, investor keeps premium Repeat process upon expiration of call option In this case, a $.54 dividend is payable on Oct 22, adding to the potential

profit

RamificationsIf investor has many choices;

Can buy back call (at a loss) and keep RYKeep profit and…

Investor can sell put against proceeds at a lower priceInvestor can invest in another company and repeat the

covered call exercise

BenefitsHigher cash flow = consistent returnDisciplined sell and purchase prices

But Upside is capped to $6.42 for 49 days

RY conclusion-Securitized PutsInvestor was “called away” from RY and sold

at $55Investor would like to reinvest in RY @ 50

Can wait in cash until this price is reached in the market

Investor can could sell $50 put and securitize the commitment Sell put $50 and collect ≈ $3.50 Commitment to buy RY@ $55 in 50 days is set aside If RY trades down to $55, put should get exercised

at net cost is $51.50 ($55-$3.50) to invest in JNJ If JNJ stays above, $55, simply repeat with new put

option

PUTTING IT ALL TOGETHER

Net Result = Higher Cash FlowCapital growth will stem from higher valuation of

companies and tends to ebb and flow with investor sentiment.

The covered call + securitized put strategy harnesses this volatility and converts into higher income at the expense of limiting violent upward movements in stocks and the onset of additional transactions.

The additional income is a buffer for investors, and can be used for day to day expenses

Strong discipline is ensured by the implicit pre determined sell and buy targets.

Quality RemainsInvestors still owns a portfolio of quality

companies≈30 stock positionsGrowing dividend income streamDiversified by country and geography

Options is a profitable to harness volatilityUsing daily price changes as an asset instead

of a liabilityIncrease the cash flow of the portfolio

CONTACT US AT 613-747-2458 OR VISIT WWW.EX-PONENT.COM