THE INC O M E P R O D U C I N G
OPTION S M O D E L ( IP O M )
Innovation In Covered Call Writing
CULTIVATE YOUR PORTFOLIO
Many investors hold large, single stock positions or positions in major markets
indices. Often, these positions sit idle, subject to daily price movements, while
collecting only small dividends. This passive investment technique can be compared
to the real estate investor who purchases a large parcel of land on the outskirts of
town in hope that it will steadily increase in value over time. Surely this approach
could pay off over time, but...
What if, in the interim, a local farmer proposes to lease the investor’s property to
produce crops? Instead of holding an idle piece of land, the investor would own a
vibrant, income producing property, cared for and watched over by the farmer,
while providing similar upside growth potential originally desired by the owner.
Introducing the Watts Gwilliam Income Producing Option Model (IPOM). The goal of
IPOM is to help Watts Gwilliam generate additional income yield on large stock or
index positions while giving the owner of the investment their desired upside
market value appreciation. The time tested model is technology driven and offers
consistent and disciplined results.
UNLOCK I NG YO UR PORTFOLIO ’S POTENTIAL THROUGH I POM :
1
CONCENTRATED OR LARGER STOCK HOLDINGS
2
INCREASED INCOME AND ENHANCED RETURNS
ON INDEX HOLDINGS
IPOM helps unleash the earnings power from
Experience the benefits of IPOM while owning
otherwise idle stock positions.
a major market index.
Works for those desiring to sell or to hold these positions.
The Watts Gwilliam IPOM strategy can dramatically
Stock must be trading above $10/share and have
options that trade on exchanges.
increase the income you receive from your
index positions.
The risk of these positions can be reduced
Minimum 10,000 shares or $500,000.
by the option income received.
Potentially generate superior risk adjusted
returns vs. S&P 500.
$100,000 minimum investment required.
“The goal of IPOM is to take an existing stock, or portfolio of stocks,
and overlay a strategy that produces an additional income yield. The
technology driving the model has led to consistent results. Investors
in the strategy have seen significant increases in the income earned
on their stock holdings.”
-Brad Gwilliam
Founding Pa rtner
1
2
3
COVERED CALL
M Y T H vs . R E A L I T Y
WHAT IS IPOM?
An option strategy that combines
owning shares of stock and selling a
call option against that position. The
seller of the call receives a premium
(income) in return for granting
another party the right to purchase
those shares at a specified price on a
future date.
IPOM is a sophisticated covered call
writing strategy that uses our proprietary options modeling software to
help our advisors continually identify
opportunities to enhance income and
capitalize from the volatility of the
markets.
Investing in options is often misunderstood. Not all option strategies are
risky. In fact, many option strategies
actually decrease the risk of a
portfolio. Covered call writing is
considered to be the safest of all
option strategies.
MAK I NG A C A SE FOR IPOM :
The Watts Gwilliam IPOM strategy is a professionally managed covered call writing strategy. If used properly,
covered calls can potentially enhance the risk adjusted performance of your portfolio or stock positions. In 2006,
Callan Associates conducted an evaluation of the CBOE S&P 500 buy write index (BXM: an index created to track the
performance of a regular covered call writing strategy). They examined the performance of the BXM in comparison
to the S&P 500. This study builds on the research conducted by Duke University professor (Whaley 2002) and
Ibbotson Associates (2005). The results of this study concluded that compared to the S&P 500, the BXM:
• Generated superior risk adjusted returns
• Produced slightly higher returns than the S&P 500
• About two-thirds the risk of the S&P 500 (As measured
by standard deviation)
• Covered call strategies can under perform stocks in
rising markets. The goal of IPOM is to stay focused on
both income and appreciation.
SUPERIOR RISK-ADJUSTED RETURNS
Annualized Return versus Risk
(June 1, 1988 - August 31, 2006)
12.5%
CBOE BXM
Annualized Sharpe Ratio
(June 1, 1988 - August 31, 2006)
0.9
0.8
S&P 500
Russell 2000
10.0%
0.765
0.758
0.7
7.5%
Sharpe Ratio
Returns
0.6
LB Aggregate
MSCI EAFE
0.4
0.352
0.3
5.0%
0.2
3-Month T-Bill
2.5%
(2.5%)
0.505
0.5
0.098
0.1
0.0%
2.5%
5.0%
7.5%
10.0%
Standard Deviation
12.5%
15.0%
17.5%
20.0%
Annualized return and standard deviations for all asset classes
over the period. The BXM generated returns comparable to the
S&P 500 at approximately two-thirds the risk.
0.0
CBOE BXM
S&P 500
Russell 2000
MSCI EAFE
LB Aggregate
Annualized sharpe ratio calculations for all asset classes over the
period. The sharpe ratio is a measure of risk adjusted returns.
These results indicated that the BXM has a superior risk-adjusted
performance to other asset classes.
TECH NOLOGY DRIVEN PLA TFORM
The IPOM enables Watts Gwilliam to apply mathematical evaluations to an
already disciplined covered call writing strategy. Using option pricing mathematics, our program provides the critical data needed to manage covered calls
without compromising the client’s long-term goals with the holding.
TAILORED TO YO UR GOALS
The IPOM system employs proven research to an options based program that
can be specifically tailored to meet your investment objectives. This sophisticated covered call writing can enhance the return on otherwise idle stock or
index positions and works if you want to sell now, later, or not at all.
PROVEN TRACK RECO RD
Watts Gwilliam principals have used this proprietary system of covered call
writing since 1999.
HOW I T WO RKS
ESTIMATED
ANNUAL INCOME
Working together with one of our specialists, a strategy
will be designed that will meet your objectives and set
NUMBER OF
COVERED CALLS
Choose up to
5 target prices
We Sell
More Calls At
Higher Prices
price targets to enter into our proprietary IPOM system.
Watts Gwilliam monitors all open option positions on an
ongoing basis and continually seeks to improve income
potential from the stock or index position. As the underlying stock values change, the IPOM will perform a series
of trades seeking to capitalize from stock movements. As
the position approaches your price target, clients have
CURRENT STOCK PRICE
the option to sell the shares or adjust price targets.
Unlike a traditional covered call approach, the IPOM
“We believe that a successful covered call strategy
identifies the “rich” covered call and sells the
must be disciplined, measurable and repeatable. If
appropriate quantity of contracts for that call.
used properly, options can be a tremendous value to
an investment strategy.”
- Jeffrey Watts, Founding Partner
WE SPECIALIZE IN COVERED CALL WRITING
While some other firms may offer options trading to those who inquire... at Watts
Gwilliam this is our focus. Your positions are continually monitored and integrated
INTEGRITY
TRUST
with the IPOM system. It is what we do. Our advisors dedicate themselves to monitoring the options market and integrating current data with the IPOM system. IPOM
offers many advantages over traditional covered call methods.
DISCIPLINE
WA T TS GWILL
IAM I POM
GWILLIAM
T RADIT IONAL CALL WRIT ING
• Balance income generation and
upside appreciation
• Experienced options professionals
• Active management
• Disciplined, proven, predictable
•
•
•
•
Limited upside potential
Narrow options experience
Reactive and sporadic management
Impulsive and unproven
THE IN COME PRODUCING OPTIONS MODEL ( IPOM )
• Introduced to clients in 1999 and refined in 2002.
• Acts as an overlay strategy. (Does not impact your current plans with these holdings.)
• Can be implemented on most stock positions including indices and ETFs.
CONSIDERATIONS:
CONTROL - Can terminate the strategy at any time. Client is in complete control of their account at all times.
PONZI / SCAM PROOF - Watts Gwilliam never takes custody of any client funds.
VISIBILITY - Client has full visibility of account at all times via online access and gets regular statements from custodian
as well as updates from Watts Gwilliam.
MINIMUM REQUIREMENTS - 10,000 shares or ~$500,000 for individual stock holdings. $100,000 for Index or
ETF holdings. Special exceptions exist.
ABOUT WA T TS GWILL IAM
SEC Registered Investment Advisor (RIA)
• Founded in 2004.
• Fee-only investment advisor.
• Trained and experienced options professionals.
Specialized in working with individuals/institutions with concentrated stock positions.
• Experienced in concentrated stock and the ability to unlock its earnings potential.
• Managed the employee stock option plan for a global semiconductor manufacturer.
• Held many seminar/webinars across the country for several publicly traded companies
on various topics surrounding employee stock ownership.
• Advocate for employee stock ownership.
Approved as a separate account manager on multiple custodial platforms.
Safety – Assets held with your current firm or your choice of custodian.
• Clients have control of funds at all times.
• Watts Gwilliam never takes custody of client funds.
• No pooling or co-mingling of your stock with others.
Since 1999, the Watts Gwilliam IPOM strategy has helped many investors unlock the earnings potential of their
portfolio. Despite the discouraging returns most investors have experienced from their stock holdings over this time,
clients utilizing the IPOM strategy have refused to sit idly on these holdings. Instead, clients engaged in IPOM have
enjoyed additional streams of income from these same positions. The following are two examples that illustrate the
value of IPOM.
STUDY
1:
CASE STU
DY 1:
A former employee of Intel Corporation acquired a significant amount of company stock over the years. At retirement,
he sold some stock, but wanted to hold a portion of the position indefinitely. The IPOM has added a significant cash
flow to supplement his retirement income, and with the success of the strategy he’s added additional shares to the
program (indicated by the yellow bar). This income is shown as the accrued cash in the chart below. This does not
include the dividends that the client continues to receive from his Intel Stock.
*See disclosure.
STOCK SYMBOL: INTC
$250,000
$30
$28
$24
$150,000
$22
$20
$18
$100,000
$16
$14
$50,000
$12
2 007
2 00 8
2 00 9
TOTA L
Y.T.D.
Aug 05-Dec 06
WG IPOM
FOR INTC
$8,164
$17,620
$130,424
$55,914
INTC STOCK
18.87%
31.65%
-45.01%
31.31%
ESTIMATED
INCOME GENERATED = $212,122
09
ly
Au
g-
Au
INTC PRICE
$0
158,500 Shares in IPOM
Ju
6
g0
05
g-
ACCUMULATED CASH
05/06
88,000 Shares in IPOM
08
40,000 Shares in IPOM
07
20,000 Shares in IPOM
Au
g-
$0
INTC STOCK PRICE
$26
Au
ACCUMULATED CASH
$200,000
STUDY
CASE STU
DY 2:
ENHANCING INCOME ON THE S&P 500: Suppose a Client has a diversified portfolio of about 1 million dollars and desires to
create additional income from their portfolio and potentially increase their returns. They choose to allocate about $100,000 of
their large cap stock holdings into the S&P 500 (ETF Ticker: SPY) and hire Watts Gwilliam to run IPOM on this holding. Over the
years, the client could have generated over $55,000 in additional income thru IPOM net of fees and trading costs. The current
value of their IPOM strategy on their SPY shares would have been $150,786. Had they not implemented IPOM the value of this
holding would have been under $100k. A difference of over $50k since June of 2004. The risk (measured by standard deviation)
of this part of their account is about two-thirds less than if they invested in just the S&P 500.
*See disclosure.
WATTS GWILLIAM SPY INCOME STRATEGY VS. S&P 500
VALUE OF WG IPOM ON S&P 500 =
$150,786
VALUE IF INVESTED IN S&P 500 =
$98,810
$200,000
$180,000
$160,000
INITIAL INVESTMENT
$113,200
$140,000
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
2 004
9
-0
8
ne
M
Ju
ar
ar
M
ar
M
ar
M
ACCUMULATED INCOME
R I S K MEASUREMENTS
S I NCE INCEPTIO N
-0
-0
6
-0
5
-0
04
nJu
ACCOUNT VALUE
7
$0
S&P 500
2 00 5
2 00 6
2 00 7
2 00 8
2009 YTD
ANNUALIZED %
SINCE
INCEPTION
June-Dec
STD DEVIATION
BETA
10.24%
.60
WG IPOM
ON SPY
8.24%
13.66%
14.08%
12.06%
-22.60 %
9.42%
4.96%
15.51%
1.0
S&P 500
9.27%
4.90%
15.80%
5.49%
-37.00%
10.97%
-1.91%
INCOME GENERATED:
$55,786
A SKE D Q UESTIONS:
FREQ UENTLY ASKE
Q: In which market environments will this strategy
Q: Can I terminate the strategy at any time?
thrive?
A: Yes. However, doing this may require closing option
A: In periods where the underlying stock is flat or down
positions at a loss. There is a chance that this loss
the IPOM will outperform a long only position. Even if
could exceed the upfront income that was earned at the
the stock appreciates, the IPOM can match or some-
onset of the strategy.
times exceed the returns of simply holding onto the
stock. Periods of rapid appreciation will likely cause
Q: Is this strategy available in retirement accounts?
the IPOM to underperform a long only strategy,
A: Yes. Selling covered call options is approved for
however both IPOM and long only would result in a
most retirement accounts, including IRA accounts.
positive outcome.
Q: Can the strategy be used on my unexercised
Q: Is it possible to prevent low basis stock from
employee stock options?
being called away?
A: Yes. However, there are several terms that must
A: The IPOM uses listed options to execute its strategy.
be met.
Listed options are American style options, which means
that it is possible for shares to be exercised prior to the
Q: What are the tax implications of the Income
maturity of the option. This rarely happens. If the
Producing Options Model (IPOM)?
client desires to retain their shares and is exercised
A: Generally, the gain or loss on the covered calls is
and called to deliver stock, Watts Gwilliam will buy
treated as a short-term capital gain. In the event that
stock in the open marketplace to deliver against the
stock is sold through a covered call, the premium
exercise of the option. This is a simultaneous transac-
received for the option is added to the sale proceeds of
tion that is normally cash flow neutral.
the stock.
Q: I currently have a margin balance against my
Q: My employer restricts me from doing any option
shares. Are they still eligible for the program?
trading on our company stock. Can I still participate?
A: Yes. In fact, many clients use the IPOM income to
A: Possibly. Under certain circumstances there are ways
hedge the cost of margin interest.
to abide by your employer restrictions and still participate in IPOM.
FOR A CUSTOMIZED PROPOSAL OR MORE INFORMATION, GO TO WWW.IPOMINFO.COM
I.P.O.M. CAN WO RK FOR :
• Individuals with 10,000 shares or $500k in single stock positions
• Institutions, pension funds, endowments
• Investors with $100k in index positions
• Investors looking to generate additional income
• Employees with vested in-the-money stock options
DISCLO SURE:
Watts Gwilliam & Co., LLC(WGC) is an SEC registered investment advisor located in Gilbert, AZ. WGC and its representatives are in compliance with
the current registration requirements imposed upon registered investment advisors by those states in which WGC maintains clients. WGC may
only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements.
Illustrations used in this document are hypothetical. The results achieved by individual clients will vary and will depend on a number of factors
including the particular underlying stock and its dividend yield, option market liquidity, interest rate levels, implied volatilities, and the client’s
expressed return and risk parameters at the time the service is initiated and during the term. Past performance is not a guarantee of future
results. Investing in options involves risk that must be considered and reviewed with a professional prior to investing. This brochure is not
intended for the giving of investment advice to any single investor or group of investors and no investor should rely upon or make any
investment decisions based solely upon the contents of the brochure. CBOE and Chicago Board Options Exchange are registered trademarks of the
CBOE, and BXMSM is a service mark of the CBOE. CBOE calculates and disseminates the BXM Index. The methodology of the BXM Index is owned by
CBOE and may be covered by one or more patents or pending patent applications.
Reference: Callan Associates Inc., An Historical Evaluation of the COE S&P 500 BuyWrite Index, October 2006
CASE STUDY 1:
The performance presentation shown above depicts the results of a single client account using the Watts Gwilliam Options Strategy during the
period July 1, 2005 through July 30, 2009. The presentation shows the share price of Intel common stock (INTC) during the period, and the
accumulated value of cash premiums received on covered call option contracts sold on INTC common stock held in the account. The presentation
incorporates the deduction of the management fee charged by Watts Gwilliam and all trading costs associated with the options strategy in the
account from the accrued cash balance. The number of INTC shares in the strategy changed (increased) over time during the period. The
presentation does not show the value of the account. The presentation is intended to illustrate the potential income earned from selling covered
call options, not the performance of a specific stock or account during the period.
During some of the periods covered by the presentation, stock market volatility and the volatility of INTC stock was higher than historic norms.
Higher volatility can be advantageous to the strategy’s performance do to the higher price obtained for call contracts sold.
Interest, dividends and other earnings were not included in the accrued income shown in the presentation. Only the cash received for covered call
contracts is shown in accrued income. The results shown do not reflect the deduction of income taxes that would be payable in a taxable account.
The results for the historic period shown should not be considered indicative of future performance. Investments can and will lose value.
The performance presentation shows the results for an account having a large concentrated position in a security. Without a large concentrated
position the potential success of the strategy may not have been possible.
All clients of Watts Gwilliam using the strategy did not experience similar results. The results are greatly dependent upon the account holding a
large concentrated stock position, the specific securities held, the clients target prices and the market behavior and volatility during the period.
This single account was selected because of its illustrative properties of the option strategy. All accounts did not perform as well.
CASE STUDY 2:
The performance presentation shown above represents hypothetical past performance of the “Watts Gwilliam SPY Income Strategy”. The
presentation of returns for the Watts Gwilliam SPY Income Strategy were calculated by using the strategy of buying the SPY security and selling
a specified quantity of call option contracts on SPY security. The quantity of calls was calculated by the IPOM (income producing options model)
which is a proprietary model that calculates the quantity of calls that should be sold against the underlying security based on the target price
(price where stock is to be sold or additional upside of the stock would be capped). The results do not represent the results of actual trading by
Watts Gwilliam using client assets but were achieved by means of retroactive application of a backtested model that was designed with the
benefit of hindsight. During the period represented in the table above, Watts Gwilliam was not managing money according to the strategy
depicted. Actual performance under the Watts Gwilliam SPY Income Strategy would have been different from the theoretical performance shown
because of a number of factors including but not limited to:
• The management fee used in the theoretical performance of 1% was the highest any client would have paid and is expected to pay
for the strategy. The fee was deducted in the end of the month following the calendar quarter end. The actual date of fee
deductions will vary.
DISCLO SURE:
• The trading costs of $1 per option contract and $7 per securities trade used in the calculations were estimated and future trading
costs will vary, affecting performance.
• The value of the option contracts was not obtained from actual historic prices, but rather was estimated through the use of the
Black Scholes Option Pricing Model. The estimated value of option contracts differs from the actual price of the option on
expiration date. The performance presentation calculates values only at month end, and option contracts are valued at their
expiration (European Option theory). In actual practice, transactions will be executed at times other than month end or options
expiration. The options pricing model used to estimate options uses historic values for market volatility and the risk free interest
rate. Pricing discrepancies between actual results and the Black-Scholes model have and will occur in options, corresponding to
extreme price changes; such events would be very rare if returns were lognormally distributed, but are observed much more often
in practice. The Black Scholes Option Pricing Model is at best an estimate, and does not capture or consider extreme market
conditions, which existed during the presentation periods.
The performance presentation shown above does not reflect the effect of paying taxes which may be a significant consideration for taxable
accounts. The performance does include the reinvestment of interest, dividends and other earnings. Past performance is no guarantee of future
results and there is the potential for loss of capital. Future securities market conditions may be affected by factors that cannot be accounted
for using historical modeling techniques.
The S&P 500 Index is an unmanaged market indexes and cannot accommodate direct investment, include the reinvestment of dividends and
interest, do not include management or transaction fees and do not consider taxes. S&P 500 is a registered trademark of The McGraw-Hill
Companies, Inc.
www.IPOMINFO.com