Options have become an increasingly valuable tool for enhancing portfolios, and we’ve integrated ETF strategies to further strengthen that approach within our model portfolios. For high net worth clients, account-level option strategies can also play an important role in aligning investments with individual client goals—whether for diversification, cash management, or tax planning.
We’re excited to highlight some of the ways our Options Overlay team is helping clients unlock these benefits.
Watch as Tenzin Phuntsok, CFA, Jake Marriott, and James Yahoudy, CFP®, discuss strategies such as:
- Protecting/diversifying concentrated, low-basis employer stock
- Replacing margin or bank borrowing with lower-cost financing solutions
- Transitioning from “Mag 7” windfall to a broader, more balanced allocation
Hope you enjoy, and please send a note to info@apt.us if there’s a particular topic you’d like to discuss further.
Full Transcript
James
All right. Good morning, everyone. Thanks for joining. My name’s James Yahoudy, and super excited about getting into the topic for today. Before we do, I’ll read a quick disclosure and we’ll get kicked off here.
The opinions expressed during this call are those of Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about the Aptus Investment Advisory services can be found in its form ADV part two, which is available upon request.
All right, well, today is a conversation and webinar that might be a little overdue, given that it’s a newer offering but not necessarily new the last month or two. We have always, if you’re not familiar with Aptus, we’ve had the expertise and the deep knowledge in the options space, the derivative space with our option based ETFs. And it just was a natural transition for us to add some team members and formalize an offering for higher net worth client needs. And we’ll get into what everything we do on the option overlay side, but just wanted to quickly welcome Ten and Jake who manage our overlay team and I’ll hand it off to those guys in just a second. If you’re not familiar with Aptus, I will do a quick overview and ultimately, the four fundamental things that we’re doing for independent advisors, our shared CIO services, our ETFs. We have multi-manager model portfolios that are available on a number of platforms, and also run a number of stock SMAs that can be integrated into your core portfolios. And lastly, the option overlay services, which we’ll get into in just a few minutes here.
So, when we think about the investment landscape for a financial advisor, and this obviously hasn’t happened overnight, our network of advisors, the type of clients they’re servicing has continued to evolve over the past couple years, and it went from a strategy, to model portfolios, to more sophisticated model portfolios, to additional sleeves that might be needed for specific income or growth needs. And lastly, the shared CIO services has been a focus of ours for a number of years now, and a lot of the custom work that we’ve been doing. Rolling up our sleeves to really try to support the higher net worth client base in a number of different ways is where this option overlay would fit into. And private investment diligence, concentrated position, risk management, tax transitions, a lot of things that really are going to add a ton of value outside of just a product. And we’re always excited to talk about these things, so please reach out to the team, anybody that you may know, whether it’s on the investment side or sales relationship side, we’re here to help. And again, thanks for joining.
So with that, I’ll pass it off to Jake. And before I do, I just wanted to say, our firm has had a really awesome growth story over the last handful of years, and a big part of it is the people that we’ve added. It’s a great culture and Jake and Ten have blended in and probably one of the two guys that from day one had made an impact on Aptus. And so, I want to thank the guys for all the work that you guys have done this year and I’ll pipe in with questions throughout. And just use the Q&A feature if you guys do have anything, we’ll look to address as many questions as we can, we’ll have some time at the end for that as well. And if we don’t get to it, we’ll hit you directly because we want to make sure that everything we’re doing here and talking through is clear and can maybe help with any specific client needs.
Jake
Awesome. Thanks, James. So, we’re going to talk a little bit about the option overlays and we’re going to start off here talking about option terminology. So we’ll give you the casual terminology, what maybe would be explained with the client, and then we’ll talk about what’s technically happening in the account, and then the benefit to the client.
So, the first thing here is the ceiling. And so that is an upside cap where we are selling a call, and if the stock is to go above that strike price, then the client is no longer participating in the upside above that. But the benefit here is we’re generating income and if the stock goes above the call strike, then we can also generate losses. To hit on the ceiling, the floor is just when we purchase a put, so that’s locking in a maximum loss over that time period. And the obvious benefit there is downside protection. Then we have the collar, which is combining the first two strategies. So we sell a call, we implement a ceiling on the stock, and we use the premium generated from that call to pay for our long put or our floor. So, that’s really combining the first two. And the benefit of that is you get the protection but you don’t have to pay as much if you were to just buy the protection outright because the call is helping pay for some of that cost.
Then we have the buffer. So I’m sure a lot of you’re familiar with the buffered ETFs, but so this would just be a downside protection where we’re buying a put and selling a put lower. And within that range, you’re protected one-for-one and if the stock was to go below the second put, then you are exposed to one-for-one downside in the stock. And this is a buffer from losses, obviously so it’s similar to the protection, but if the stock were to go significantly down and the strategy wasn’t actively managed, then you would have additional downside exposure. Go to the next slide.
So we put the strategies into three buckets, and these are three different types of clients that we can help. And the first bucket is the income. And what we’re doing here is we’re meeting an income need with the goal of retaining the shares. So this is conservative covered calls, lower delta, lower likelihood of finishing in the money, with the goal of collecting that premium and not having to sell any shares. Obviously, we can’t guarantee that and there may be, if the stock is to run up significantly, a time where we have to sell a few shares or come up with cash elsewhere within the portfolio, but that’s the ultimate goal of the strategy.
Then we have transition, and this is for a client who is actively looking to transition out of their position into a more diversified portfolio. And these two differ because in the transition we’re going to sell more aggressive calls, so calls that are closer to the money. That will in turn generate more in income and it will also increase the likelihood of that option finishing in the money. And if the stock does go above the call strike, we would lock in a loss in that short call option and use that loss to offset the gain from the sale of underlying stock. So over time the stock runs up above our call strike, we generate a loss, and then we use that loss to offset the sale of the underlying stock and we use the proceeds to diversify into a more diversified portfolio.
Finally, we have the hedging strategies. We have a bunch of different flavors of hedging, but the main goal is just for downside protection. And depending on the client’s risk tolerance or willingness to sell shares or provide cash for the strategy, we cover a bunch of different scenarios there on the next slide here.
So, here we have the four different hedging strategies and I’ll just run through quickly when these make the most sense for clients. So, the put purchase is going to be your best protection because it’s just one-for-one protection on the downside, but it is the most costly. So, it requires a significant at cash outlay oftentimes, and so that’s why it’s not as common of a strategy, but it provides great downside protection. It can be used for a client who’s bullish on the stock, wants to have all of that upside participation, but is maybe concerned about a significant drawdown because it makes up such a large portion of their net worth and if the stock was to go down significantly, maybe their planning changes or their lifestyle would have to change.
Next we have the caller strategy, which is the most common. And what we’re doing here, I hit on earlier, but we’re selling a call, we’re using the premium to buy protection. And the big benefit of this strategy is it can be structured as costless. So add implementation, it requires no cash outlay for the client, and that’s the main benefit of the collar strategy. We are locking in a floor but we have a capped upside, and that upside is paying for our protection.
Then we have a put spread strategy. This is a buffer on the downside, similar to the buffered strategies in ETS where we’re buying protection and selling protection. And the benefit of this is it provides downside protection with unlimited upside, like the put purchase, but it’s less expensive because you’re collecting some premium for selling that lower strike put. It’s great for a client who’s bullish but saw the cost of the put protection outright and said, “That’s too much for me, but I’m willing to maybe cut it in half by selling a put lower.”
And finally, we have the buffered collar, which is throwing all of these together. We have the downside buffer and then we’re also selling a call. And the buffered collar strategy is best for a client who saw the collar strategy but is looking for more upside participation. And the way we can do that is we collect the premium through the short put, and then we use that along with the short call to pay for our protection, allowing us to sell on further out of the money call and participate in more of the upside. Next slide, James.
So the big question is, what separates us from our peers in this options overlay strategy? The first lever that we can adjust is we have no calendar constraints. We’re not handcuffed to a systematic process. Essentially it comes down to us picking the best option at the time of implementation. So for short calls, we’re willing to sell calls two months or less because that would allow the client to gain that premium more quickly. And for callers or other hedging strategies, we’re generally looking between three and six months, and that’s going to depend on that specific stock, whether there’s events in the future, what implied volatility looks like over that timeline. So, we’re not a set it and forget it, we’re really looking at the stock at the situation at hand and picking the best option.
And then the second lever would be the active management. So, we like to say that stocks move fast and options move faster. So, there’s oftentimes where it’s advantageous to adjust the structure as the underlying stock moves. So the most common would be a cover call strategy here, where let’s say you sell a call at 100, the stock goes down significantly, and we’ve collected 80, 90% of that premium over a short period of time. We’re going to close out that option. We won, we collected our premium quickly, and wait for an uptick in the stock or an uptick in implied volatility to sell a new call.
And then finally, we have the monetize and redeploy. So this is focusing on the put sides of the strategy, the protection, and what we’re doing here is if the stock was to go down below our put strike, then we’re going to monetize or take profits from this insurance while we have it and while the stock is down. And then those proceeds can be used to diversify or to buy more of the stock, whatever the client prefers. But that’s something that we’re going to hit on a little later in the Apple case study.
But first, we’re going to talk about the NVIDIA, and this case is focusing just on the cover call side and it’s really hitting on the benefits of shorter and active, so the first two levers that we mentioned on the last slide. And so what we’re doing here is we’re showing four different ways of implementing a cover call strategy and seeing how they would’ve performed over two different extremes. So you have a year where NVIDIA is up significantly, and then a year where NIVIDA is down significantly, and we test out these four implementations of the strategy.
So the first one is the most passive, it is a six month sell a call. These are all 10 delta calls, so the same risk. And so, we’re going to sell a six month and hold until expiration. Then the second one is sell a three month, so that’s showing the benefits of shorter and hold it until expiration. Then we have two active strategies, where they’re both three months, one of them we’re rolling every time the call finishes in the money. So the first day that the stock goes above the call strike, we’re buying back that call at a loss, selling the minimum shares to cover, and then selling a new 10 delta call. And the last one is combining the third strategy with another active management, which is the one I explained earlier, where you sell a call and the stock goes down significantly in a short period of time. And once we’ve collected 90% of the premium on that call, we’re going to buy it back and then sell a new 10 delta call.
So, we jumped to 2024 and 2025, and-
James
Hey, Jake.
Jake
Yeah.
James
Can you, just to make sure everybody’s on the same page, that 10 delta call, can you just explain what that is for people?
Jake
Yeah, that’s a good point. So 10 delta call, delta is often used as a approximate likelihood of a stock finishing in the money or of an option finishing in the money. And so that would say there’s approximately a 10% chance at the time in which we sell that call of it finishing in the money. So this would be on the conservative side. This would be like a covered call income client risk tolerance.
So in January 2024 to 2025, NVIDIA was up 190% over this time period. The reason we picked the video is we see this as an example where if you sold six-month calls, you only would’ve participated in 70% of that 190% run. And we’ve had multiple examples where advisors and clients are upset that, hey, we know we capped our upside, but we thought we were going to have more upside participation in this or didn’t realize the extreme movements that could happen.
So, we’ll see here that the first strategy, the most passive, 70% upside participation, and 3.5% in premium collected. Then you’ll see the benefits of being shorter here, the three-month strategy, which is resetting that cap twice as often, is going to participate in 110% upside and collect 8.2% in premium. So, more than double the premium and almost double the upside participation. And then you have the benefits of the active management. So if we’re rolling this each time the stock goes in the money, we would’ve participated in 154% of the upside participation. And because we’re actively rolling and selling more calls, we’re also going to generate more premium here at 12.5% premium. The last strategy here slightly underperformed because we’re rolling where the stock or when we’ve collected 90% of premium. And one of those times where we immediately rolled into a new 10 delta, the stock immediately went up significantly through our call strike. So generating more income because we’re selling more calls, but slightly underperforming the just roll in the money.
But the main point here is, there’s a clear benefit of being shorter and actively managing the strategy in a year where NVIDIA is up significantly.
James
Jake, one thing that came up on a call recently. We were talking about the benefits of shorter term option overlays, and I’m just curious if you have a six or 12 month cover call type strategy and you have a day like Oracle has today, what is the impact to the strategy if you have longer term options? Are you stuck or how would a manager change in that type of scenario?
Jake
Yeah, if you have, let’s say five months left on a call sale that in the case of Oracle where the stock’s up 30% today, you really are somewhat handcuffed because there’s so much time left until that call expires that you’re going to have to pay way more than the amount that the option is in the money to close it out. And then you’re extending it another month so you still have six months where this stock can rip through the call strike. So, it’s a great question. One of the benefits of shorter is just we have the flexibility to roll that call up and out more frequently if you do get a run like Oracle or like we’ve seen in some of the NVIDIA and other tech names. So, it’s more important on higher volatility names to write shorter calls because you’re not giving it as much time to run through the upside cap. And if it does run through in a shorter period of time, you have flexibility to roll it out more actively.
James
We had a question on the shares column. Can you just explain what those mean?
Jake
Yeah, so this is the number of shares that were needed to be sold. So for example, the six-month hold at expiration, when we had to buy back that option for a loss, how we cover the cost of that loss is by selling the minimum number of shares that offsets the loss and the options. So another benefit obviously is you retained a lot of your shares if you were shorter and more active. But yeah, that’s just the number of shares needed to sell to offset the losses from the options.
So now, we’re jumping to January 2022 to 2023, where NVIDIA had a very different performance, were down 42% over that time period. If you had sold the six months and passively, then you collected all of your two and a half or 2.2% in premium and the stock never went in the money. And you’ll see that just by being three months, by shortening that tenor, we would’ve collected more in premium because we sold more calls. So, we would’ve collected 3.22% premium. There was never a time where these options finished in the money, so the rolling in the money doesn’t do us any good here. But here’s where we have another benefit of active management is, there were multiple times where we sold a call, NVIDIA went down immediately after, and we collected 90% of the gain very quickly. And so we closed out that option and sold a new option generating more premium. And you’ll see, we were able to generate over 6.5% in premium by actively managing the call.
So now we’re going to jump to the protection side of things. This is for this year through January to 8/15. And in this client example, the client is looking to protect their Apple position, their concentrated Apple position, but they’re bullish on the stock, they don’t want to sell any shares. So we hit on earlier when we would use different hedging strategies, and if the client is not willing to sell any shares, the only way you can guarantee there’s no need to sell shares is by not selling a call. So this strategy we’re doing a put spread a buffer on the downside, and the client agrees to spend 2.5% of the notional of this position for the year on protection, so about 70K for this specific client.
And we had a significant drawdown in April and Apple was one that got hit pretty hard. So by actively managing this put spread strategy, we were able to, over those first eight months, we were up 119 net profit over that time period, and that helped limit a lot of the decline in Apple stock. And now, because we don’t have that call, if Apple were to run up through the rest of the year, we would still be outperforming Apple to the upside. So there’s obviously a chance now where Apple could finish up on the year, but we still collected that 119 in net profit in the put strategy. But the next slide does a really good job of showing the benefits of actively managing this put spread.
So, you’ll see in the beginning of the year, or let me explain the chart. So the blue line is Apple stock price, on the left side it shows you the stock price. The green line is the put that we are long, so that’s where our protection starts. The red line is the put we are short, which is where the client would feel one-for-one downside below that. And then these light gray lines here are showing when we monetize the protection, so when we actively managed it and took profits from our insurance.
So you’ll see in late January, Apple stock goes below our 225 put strike, and we rolled it down to 195, taken out 40, around 45,000 in gains from that put protection, while still maintaining protection. It’s not like we took the protection off, we just rolled it down. And then Apple goes back up to all-time high, 245, so year high, year-to-date highs, and we reset that cap or we reset the floor back to a little higher at the 225 level again. Then you’ll see in March, Apple starts to fall and it goes in the money here, and we roll down that entire put structure and we take out some gains and then Apple recovers slightly. And then we got the April, the big downside in Apple where we actually reset the structure three times in about a week just because the stock kept going down, and we took out a significant amount of gains from this insurance.
And the coolest thing is, that had we not actively managed the strategy and we owned, I think it was like the 210, 185 put spread, that at expiration, if we had held it all the way to expiration, would’ve expired worthless. So, rather than sitting on our hands and hoping that our insurance is worth something at expiration, we took profits as the stock was down, we had those profits here shown in the light gray lines, and then as Apple recovers, we participate in all of that upside. Any questions on that one, James?
James
I was waiting for the audience. I don’t see any from the audience, but I’m just curious, how common would a put spread be from other option overlay providers, or what’s the challenge with a longer-term structure when you’re more passive in your structure? What would be the, you said it would expire worthless, I understand that, but is it also more just the customization and time that it’ll take to actually implement this strategy? Is that why we don’t see this as much with other providers?
Jake
Yeah, you’re spot on. The put spread and buffer collars aren’t as common, and the big reason is that they work much better when you’re actively managing them. If the client doesn’t like to hear that they’re going to, this is a left tail risk, we’re concerned about the stock falling dramatically. So if you say like, oh yeah, but if it goes down 30%, then you’re going to start to feel that downside. So if you’re passive, you have that risk, but the active nature allows us to adjust that buffer as the stock moves.
So you’ll see here in April, if we hadn’t moved down that structure, the stock at one point would’ve been below our put sale and they would’ve started to feel that downside below that put sale, where we were able to actively manage it as the stock went down. So I think it’s just a lot to do with the active nature allows the put spread strategy to be more attractive. And yeah, like you said, it’s a lot of work. We have to be watching the stock and it’s not just, we’re going to implement it, we’re going to implement a six-month put spread and if it’s in the money at expiration then we’ll take the gain and if it’s not, then we’ll just roll a new one. We’re looking at this daily and that daily monitoring and active management is what makes the put spread and buffer collar strategies more attractive.
James
Okay. We had a few other questions come in. Are your strategy overlays, can we use them in existing client accounts or do we need to open up a separate account for them?
Jake
We can trade it within the existing account. The one thing that comes to mind is if you can only have one manager outside manager tied to an account. So if you had them direct indexing account or something like that, it’s already tagged, and that would be the only time where you would need to separate it and open a new account. So yeah, oftentimes we’re able to trade it where it is with no restrictions. And just to clarify also, we would only be billing on that concentrated position that we’re managing the strategy on.
James
Okay, understood. And there was a question on profit income on the Apple trade. And just to clarify, so there’s no income, this is a net debit, the client is paying for protection if you see here. And then the trade as of-
Jake
8/15.
James
… 8/15 is showing 119 in profit. And I don’t know if there’s anything else you wanted to add there, Jake, to that question?
Jake
Yeah, I would just say that, that because we aren’t selling a call in that strategy, and I think I did hit on this earlier, but that 119 in net profit is, that outperformance should continue as the stock goes up because we’re not capped on the upside. So there’s a scenario where you could have a put strategy, a put spread strategy, if the stock has a significant downturn, you could be up on your put strategy and the stock could be up at the end of the year. So, I think that’s a huge benefit of the put spread strategy and monetizing those puts when the stock is down, is you’re getting paid for your insurance when the stock is down and you still have unlimited upside minus the cost of the protection.
James
Got it. So now, put spread strategy just to be clear or just a put only strategy, it would be a debit to the client, they would have to pay for that type of scenario. Caller is where you can maybe sell away some of your upside to cover your protections, just to make sure everybody’s on the same page.
All right, I think maybe we want to shift gears and we’re just touching on some of the services that we provide at the end. We have a outline of the minimums and cost structure and we can share the slides as well, but there are other things that we’re probably not going to focus as much on, but just wanted to let you guys know. Ten, I’ll give you the mic. I think it’s yours, right?
Tenzin
Yep. Yeah, thank you, James.
So yeah, under our options overlay umbrella, in addition to our concentrated solutions, we have our alternative cash and credit. Today we’re focusing more on the credit lending side, just because we’re seeing a high demand for it.
I’m not sure how familiar you are with the box ETF. Essentially what they do is, they are long the box spread, so they’re buying the box spread and they’re replicating a zero coupon bond that are closer to a treasury rate. So a synthetic T bill, let’s say for example, they pay $96 today and then they get 100 at maturity or at expiration. Well, since these are options trades, we can take the opposite side of the same legs and when we sell the box, now we’re able to actually replicate a margin loan that’s closer to the treasury rate. So in the same scenario, instead of paying the 96, you’re actually getting the 96 today and then you’re paying $100 at the end of expiration, so that $4 would be your implied interest.
So, looking closer with what our alternate credit looks like in comparison to a traditional custodian margin loan, as you can see, the interest rate we’re actually much closer to the treasury rate and those numbers based off end of July. As compared to the margin loans, you can see between eight to almost 13%, and those numbers are from Fidelity and Schwab. In terms of taxes, the interest that you’re paying are treated as capital losses and in our scenario, it’ll be 60% long term, 40% short term. We’ll talk about it a little bit later just because we are using index options. Compared to for margin interest, they are net against your investment income. So for instance, if your investment income is $1,000 for the year and then your margin interest was 1,200, you can only net off that thousand that you actually made in the investment income.
Similarly, since we were kind of replicating a margin loan, the assets are still held at the account. The only difference would be for our alternative credit, they’ll see the four options leg as positions in the account itself. One big advantage of the short box spread compared to a margin loan is it’s compounded, or in our case since we’re rolling it one year at a time, it’ll be compounded yearly versus for the margin loan they’re compounded daily. And we’ll look at some of the numbers in I think in two slides.
James
Hey Ten, just jumping in here, would this credit or line of cash for clients, would it be used for shorter term needs, longer term? How would you think about that?
Tenzin
Yeah, we can do either one. So for a margin replication it would be more so we’ll just keep rolling it. So similar to a margin loan where it keeps accruing, we can keep rolling the credit line, while we’ve also seen cases where a client needs a down payment for the next seven months and then we can just create that structure as well.
James
Okay. And of course, the benefit for the advisor and of course the client is they remain invested in this scenario. Awesome.
Tenzin
All right, so just looking at how it actually works. So again, we’re selling a box spread and we’re designing it using index options. There are a couple of reasons why we use index options. One, they’re inherently European and cash settled, so there’s no early exercise or delivery of any underlying assets, everything is settled via cash. And secondly, that the tax treatment of the 60% and 40%, 60% long-term, 40% short term, specifically for a shorter term. And then in terms of how much they can borrow, we put up a one third of the aggregate position and that’s looking at the worst case scenario. So for example, a client with just one concentrated position, but you can actually take up to half under a red T. But the maintenance threshold really depends on account by account basis, depending on if the portfolio is just equities, with fixed income. So the good thing is at the custodian under balance, it actually shows how much you can borrow. So each client can just go into their account and we’ll actually be able to tell you based on their calculation how much we can borrow.
In terms of the credit or the loan that we create, it’ll be cash in the account so it could be withdrawn or could be reinvested back into the account. And as long as the withdrawal or the investment is no more than the credit we generate, there’s no margin that’s being accrued. For our default. Like I mentioned earlier, we’ll essentially be rolling that loan each year. So for example, we create $96 today, in a year we need to pay off the $100. While at expiration what we’ll do is we’ll design a new box spread that will generate the $100, and now your new loan notional would be let’s say 104, $105. And then that new loan, the new implied interest would be whatever the one-year rate would be at that time. In terms of management fees, like any other sub advisors, will just be taking it directly from the cash from the account on a quarterly basis. And next slide. All right, perfect.
So now looking more in this example with how the math works. So if we have a $3 million account, one with the alternative credit with us and one with the traditional custodian margin loan, if the client needed a million dollars today, well the margin loans are pretty easy. You can just take out the million dollars today and then the loan notional would be the million dollars. On our case, the loan notional be a little bit higher but it will bake in the interest itself so the loan notional in this example, based on the interest rate we were seeing at the time, it’ll be closer to $1,048,000 to $1,050,000. Interest rate, you can see it’s almost half. So therefore even with the management fees, the total expense is much lower and in this case, the client could be looking to save from $26,500 to over $72,000. Additionally, this doesn’t account for the fact that $48,200 to $50,700, that implied interest is actually a capital loss, which could be netted out against any other capital gains in the account itself, versus the margin interest you can’t do that.
Perfect. So in terms of the mechanics, I don’t want to make it too complicated, but you can either look at it as a short call spread and a short put spread. I like to think of it as more as a synthetic short and a synthetic long. So in this scenario you’re basically shorting the stock, so it doesn’t matter where the stock ends up, we’re creating a fixed payoff. So shorting the stock at 6,000 and going long at 7,000, that spread is your payment, that fixed payment at expiration. And to essentially take that risk, someone is willing to pay you or whoever’s taking the other side is willing to pay you that $960 today to get that payment, $1,000 at expiration, and that $40 is your implied interest rate. So yeah, I like to look at it as a short and a long with a fixed payout.
Perfect. So, going into one of the recent cases that we’ve run into. The first one was we had a client with $3 million account with about 30% in muni bonds yielding four to 5%. And they were actually looking to sell out of some of their assets and generate $500,000 to pay a down payment on a house. What we proposed was selling out of those bonds and reallocating into assets with higher CAGR. And now that they’re invested in assets that have bigger engine, bigger breaks, we can sell the box spread at a sub 5% implied interest rate. And for the client, now they’re invested in higher return assets with better purchasing power defense and immediate access to low cost financing. When I say immediate, as long as we have the options trading capability at the account and the firm level, we can execute the trade today and then within two business days the cash should be settled in the account.
Another case that we ran into was an account that already had an existing high interest margin loan. It was a $1.2 million account with almost 400,000 in margin balance paying almost 11%. And for that client, what we did was we sold a box spread generating about 440,000 in credit, so eliminating that 430,000 balance, plus some buffer for fees and whatnot. And that box itself also came out to sell 5% implied interest rate for the client. Their margin loan, they were paying over $3,000 in margin interest that was being accrued every day or compounded every day, while we cut that down to a 1,600 interest rate and that was fixed for the year. And then it fixed for the year and then when we roll it, it’ll be whatever that one year treasury would be at that time. So at the end, we cut their margin interest in half, and then reducing the drag on the portfolio from it almost 11% to less than 5%.
James
All right, I’ll jump in. What’s the risk here versus a more traditional loan?
Tenzin
Sure. Perfect. Yeah, so, well, one risk that you still have would be the portfolio going down significantly and getting a margin call. So that would be the same risk as a traditional margin loan as well. Second would be, because these are actual trades and not a balance sheet product, there is execution variance. So it’s not clean cut as a margin loan that says, hey, 10.83%. But what we do know is it’s going to be much closer to a treasury rate than whatever margin rate that they’re charging. And then if you go on the next slide, that will be the one big difference, because all option trades are cleared through the OCC. There’s a, you just need to be cognizant of the counterparted risk that the OCC is the one, or the counterparted risk against the OCC.
James
And to clarify the execution risk, you’re saying that the rate before the trades is not defined, it’s going to be within a range near treasuries, but once that trade is executed, the rate is fixed?
Tenzin
That is correct, yes. So it’s not like we can say, hey, you’re going to get 4.8. We know it’s going to be around there, but depending on the spreads and the liquidity in the market, it will vary slightly.
James
Okay, awesome. So, there’s quite a few questions. We’re going to make sure we wrap up here within the next couple minutes. Just to make sure you guys are aware, there’s a number of resources on our content hub. And for more specific information on what we do or a specific case, you can just hit us at info at apt.us or whoever you may have a relationship with within our company, feel free to go that route as well.
One question that maybe stuck out, will we discuss capital gains and losses of puts and calls, kind of how that’s treated.
Jake
Yeah, I’m happy to hit on that real quick. So income from cover calls is going to be taxed at the short-term income rate of the client. And then for the put side, generally, we’re looking at less than a year. So that also gains from puts would also be taxed at the short-term rate. But the benefit of the puts, like in the put spread strategy for Apple is, that’s cash you would otherwise not have. So it’s downside protection, you do have to pay taxes on the gains from the put strategy, and that would be short-term capital gain.
James
Okay. Maybe on that front you could touch quickly on a tax transition, how that may offset some of gains from stocks and all that, how that would function.
Jake
Yeah, so like I said, the income from the tax, so what James is asking about is a cover call transition client who’s looking to exit their concentrated position and diversify. So, we’re selling more aggressive cover calls in that scenario. The income generated from those cover calls is going to be a short-term capital gain, but if the stock does go above the call strike and we have to buy that option back for more than what we initially collected, then there will be a loss, a short-term capital loss in the account. And that loss can be used to offset the long-term gains from the concentrated position. So, depending on the basis of the underlying stock, we may be able to sell twice as much of the shares for the losses and the options to offset the gains from the underlying stock.
James
There was a question on fee structure and availability. Schwab and Fidelity is where we are available today. If you custody somewhere else, feel free to touch base with us to see if maybe there’s an opportunity for us to get set up. It may be advisor or custodial specific, just depending on if we can go down that route.
And we didn’t cover all of this as mentioned earlier, the option overlay, which is the top part of the screen is what Jake focused on. And then the alternative box spread solutions, which would be both for alternative lending type of solutions and for cash management, would be that bottom section. And the two in the middle. The premium income on stock sleeves, those are our stock sleeves that we run and we’re running a cover call strategy around those sleeves. I think there was a question on a stock portfolio that we offer options based strategies with, and those would fall under that bucket.
Jake
Yeah, and James, just to add onto that. For both of those premium income strategies, we’re selling conservative cover calls, so it’s more like a cover call income. So for the compounder sleeve, we’re targeting 2.5 to 3% in annualized income, and for the core sleeve it’d be closer to 3% or more.
James
And that would be in addition to the stock portfolio or in aggregate, the two?
Jake
Yes, that’s just premium income. So, that does not include the dividends with the underlying stocks.
James
Awesome, okay. All right, well we went maybe a little longer than we wanted to, but there was a lot of really good questions. So, we’ll go ahead and wrap it there and we’ll look through if there are any questions that we didn’t get to, we’ll hit you directly. Thanks everybody for joining. Thanks Jake and Ten, and please reach out with any questions, we’re here to help.
Jake
Thank you, see you.
Tenzin
Thank you.
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