ACE Strategies

Stock Index Premium Collection Strategy (SIPC).

ACE's Stock Index Premium Collection (SIPC) strategy writes call and put options on the S&P 500 index futures. The strategy balances option positions, where price changes and volatility are constantly changing, and exploits the time decay aspect of option premiums. There are twelve cycles per year, ending on options expiration each month. Profitable outcomes can occur whether the S&P is up, down, or sideways as long as its price stays within a predetermined range. It works best when the market is somewhat, but not excessively volatile. Bear in mind, past performance is not indicative of future results.

Many investors are focused on a single strategy that is successful only when the market is trending higher. In reality, we know that quite often the market is not trending at all, neither up nor down. Most of the time it is in more of a zig-zag mode called a "consolidation." Therefore, when the market is in this condition, ACE uses a strategy to take advantage of the choppiness and non-direction. A basic tenet of this strategy is that, at times, it is best to determine where the market will not go versus where the market will go.

The strategy collects premiums by writing (selling) options on the S&P 500 index future, though occasionally other indexes may be used. The seller (writer) of an option risks losing the difference between the premium received for the option and the price of the underlying futures contract that the writer may be assigned upon exercise of the option.

A determination, educated by research and technical analysis, is made of the likely market trading range in the short term. Research shows that over the last ten years the S&P 500 Index, in any 30 day period, generally trades within a certain range. Based on that, our strategy seeks to implement the selling of options outside that range on a monthly basis. That means that call and put options, most often in pairs, are sold at different strike prices above and below the anticipated market trading range. Within this range the market can go up or down, or trade flat and the options sold can still expire worthless, to the sellers advantage, at the end of the cycle. Most often, options expire at a loss to the buyer and a gain to the seller.

Trades are usually initiated between four and six weeks from expiration. Positions are often held until then, at which point (and as intended) they may expire with their total value lost. That event maximizes the return for the option pair (known as a "strangle") by retaining all the funds received into the account when the option was initially sold. However, there are times when positions may be bought back (covered) before expiration for several possible reasons. They include, to protect profits, to increase the profit potential for the next cycle by sellers, and to avoid or minimize a likely loss. The cycle is repeated continuously, market conditions permitting. The goal is to achieve a profitable outcome for the client regardless of the direction of the price movement of the underlying index, so long as the index price remains within the range of the strike prices of the options sold. As a consequence, although not guaranteed, we have demonstrated, and continue to believe that profitable situations can be realized both in bear markets, bull markets or, best of all, when markets are mostly moving sequentially up and down within a range.

The amount collected, called "premium", is affected by three factors… price, time, and volatility. "Price" simply refers to the relationship of the strike price to the Index price. The closer they are, the higher the premium. "Time" refers to the time left until expiration. All things being equal, we know to a certainty that any option will be worth less tomorrow than it is today. Thus, we refer to "time" as a wasting asset with predictable decay characteristics. An option with greater time remaining until expiration will command a higher premium. Higher market "volatility" similarly will result in higher option premiums. Prior to establishing a position, without considering direction, high volatility benefits the seller and low volatility benefits the buyer. Conversely, after setting up a position, without considering direction, low volatility benefits the seller and high volatility benefits the buyer. Therefore, continuous monitoring and adjustment to market volatility is another key to the success of this strategy.

An outstanding characteristic of this strategy is its flexibility. There are, many tactical alternatives to choose from depending upon the market movement, volatility and other external factors. To cite a few examples, even in periods of high volatility, (considered risky in other strategies) options can be sold at further-away-from-market strike prices, creating a significantly wider range between the call and the put, and still obtain the goal of reasonable return vs. risk. Similarly, placements can be adjusted to somewhat lower return for the relative safety of further out options. Also, there is the ability to adjust the number of options on either the put side or the call side, to accommodate index price strength in one direction.

A helpful way to look at this strategy for some investors is to view it as similar to an insurance company selling insurance against, say, earthquakes in Washington, D.C. In our case, you, the investor, are insuring other investors against potential losses if the market goes outside of a defined price range. Any insurance company collects a premium for its willingness to assume risk and so do you in our strategy. However, unlike an insurance company, which must operate within the confines of its policy, the strangle trader can get out of his contract by merely going into the market and buying back (offsetting) his original position. He may give this serious consideration especially if the arrow on the Richter scale jumps, thereby limiting his loss.

Still another favorable attribute of the strategy is that as positions expire or are closed out each month, the opportunity is presented to adjust the range, for the next cycle consistent with market price movement, up or down. This not only controls the risk but also enhances the achievement of pre-determined objectives. Investors who hold long-term positions in stocks can only envy the opportunity to start over each month with an adjusted price arrangement tuned to changes in the market while pocketing profits in most months along the way.

It is useful to know that those on the opposite side of the trade include, primarily, institutional stock portfolio managers and secondarily speculators. Most institutions find it essential to hedge their long portfolios by buying options as protection (insurance). They often choose the S&P 500 futures options as their hedging vehicle since that index represents as much as 70%+ of all U.S. corporation market capitalization. It is also one of the most actively traded futures contracts in the world and, therefore offers impressive liquidity advantages versus other stock index future options.

There are at least three protective approaches that we use when the market acts differently than expected. The first is simply to close the position, to "cover." This may incur a loss on a particular trade but prevent the possibility of a larger loss if the position were retained. Second is to cover and "roll" simultaneously (or nearly simultaneously) by selling another position in the same or subsequent months. Rolling returns premium to the account immediately although it may not offset the full loss of covering. It does, however, give us the opportunity to recover the losses upon market stabilization. A third way out is to buy (if the errant move is to the upside) or sell (if the opposite) the index future itself at or near the strike price. This will alter the position to a covered call (or covered put) that can improve characteristics of the original position. In summary, selling strangles on the S&P 500 index futures can be an important addition to any portfolio seeking a growth component. Compared with individual stock investments or buying options, where decisions on all three variables (time, price and volatility) must be correct to achieve great success, the option seller only needs to have one of three in his favor.

It is our belief this strategy appeals mostly to those investors looking for an alternative growth strategy which has the potential to gain larger than average returns for larger than average, but, calculated, risk. In the Advisor's opinion, a minimum of 18 months should be allowed to experience a full cycle of the strategy before evaluating performance.

We have two programs in this strategy, Regular and Institutional. Both use the identical format of options on the S&P future index. The Institutional program requirements for minimum starting value is higher than that for the Regular program (see below) and, therefore can be traded with greater flexibility.

Stock Index Premium Collection Strategy - Minimum Starting Value Required*
Regular Program $75,000
Institutional Program $250,000

Lesser amounts may be accepted solely at the discretion of the Advisor.
*Stated minimums are net of any front-end fees.

THERE IS SUBSTANTIAL RISK OF LOSS IN TRADING FUTURES AND OPTIONS.  ONE MUST BE AWARE THAT THE POSSIBILITY OF UNLIMITED LOSS EXISTS IN WRITING OPTIONS.  PEOPLE CAN AND DO LOSE MONEY.