Case Studies

Cash Flow

Mary Investor is a retired individual. She has savings of approximately $1 million, half of which is invested in stocks and stock mutual funds. Mary has cash flow needs and is invested in government bonds, municipal bonds, and corporate bonds. She would like to generate some additional cash flow and is considering putting more of her money into bonds or possibly some higher dividend yielding stocks. She asks her financial advisor, who is also her CPA, what she should do. Her advisor makes the following suggestion: She should take $200,000 and invest in the Optima Portfolio strategy. The premium income generated by writing covered calls, which is taxed as Short Term Capital Gains, can be offset by Ms. Investor’s capital losses. Until those losses are all used up, Mary can have a stream of income that isn’t taxable.

Concentrated Stock

An investor has been investing in shares of XYZ company since the 1950 and has built up a sizable position. He was receiving a steady stream of dividend income, but recently XYZ cut their dividend to almost nothing! Ken considers liquidating some of his position but he does not want to pay the capital gains tax when he sells shares that he purchased at such a low basis. He always imagined that he would leave the stock to his children anyway and knows that they will receive a step up in basis. Ken’s advisor makes the following suggestion: Ken should take the position and invest in the Optima Overwrite strategy. California Investment Trust will systematically write covered call options against shares of XYZ company in order to generate the income that Ken needs.

Defined Benefit The Trustees of a Defined Benefit pension plan have a problem. Each year, the company receives information from their actuary letting them know how much of a contribution they are required to make to the plan. For several years now the trustees, all of whom are participants in this plan, have been surprised by the number that their actuary has given them. In 2007, each was able to contribute significantly less than he had expected (which meant more taxable income) and in 2008 he wound up having to contribute more. The Trust’s financial advisor explained to him that there is an actuarial rate of return assumption that is factored into the year’s contribution. If the underlying investments outperform this assumed rate of return, the next year’s contribution is limited. If the investments underperform, the company must make a larger contribution the following year. The Trustees want an investment that has the potential to achieve the assumed rate of return but with less volatility. The financial ad visor , a wise and savvy investor himself, suggests the California Investment Trust Optima Total Portfolio. In this strategy, California Investment Trust’s portfolio management team first builds an asset allocation using the principles of Model Portfolio Theory to select an allocation of debt and equity securities that falls along the efficient frontier – the lowest level of risk for a targeted rate of return. Then they overlay covered calls, which has been proven to further reduce volatility.

Risk Reduction

A client goes to see his financial advisor. He has been investing in a portfolio of blue chip stocks for years now and he tells his advisor that he would like something with a little bit less risk. “I know stocks go up and stocks go down, but I’d like them to do it just a little less.” He continues to tell his advisor that if he could invest in the same type of stocks but with about a third less risk, then he would be satisfied. This advisor is familiar with the buy write strategy and suggests that this client invest in the Optima Portfolio. He gets the benefit of professional stock selection and by writing covered calls against each position, California Investment Trust can reduce the standard deviation (volatility) of the portfolio. In fact, the advisor goes on to show his client a third party article by Callan Associates discussing the results of the buy write strategy which was able to generate market returns with one third less risk over an 18 year period.

Option trading is not suitable for all investors. Investors should read and understand the Characteristics and Risks of Standardized Options.