Concentrated Stock Overlay INCREMENTAL INCOME FROM CONCENTRATED WEALTH

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1 Concentrated Stock Overlay INCREMENTAL INCOME FROM CONCENTRATED WEALTH

2 INTRODUCING RAMPART CONCENTRATED STOCK OVERLAY STRATEGY When a portfolio includes a concentrated equity position, the risk created by volatility in that stock, coupled with diversification limitations, may create unwanted investment challenges. At the same time, factors such as taxes, market valuations, and a range of other considerations often lead to deferring the decision to liquidate all or part of a position. As an alternative to an outright sale, the investor who is interested in making his or her concentrated equity position more productive may benefit from employing a covered call writing strategy. The Rampart Concentrated Stock Overlay ( CSO ) Strategy is a covered call writing strategy structured to help an investor increase the utilization of a concentrated stock position. Applying Rampart Investment Management s dynamic covered call option overlay may help improve the risk/return profile of the position while generating income in addition to any dividends the stock already pays. A leader in the utilization of strategic option strategies, Rampart s covered call strategy gives clients the flexibility to set parameters that match their specified risk/reward investment objectives. The proprietary information technology platform, the Rampart Options Management System ( ROMS ), enables the portfolio managers to effectively evaluate, monitor, and execute option positions.

3 AN OVERVIEW OF OPTIONS A call option is an option contract that gives the buyer the right, but not the obligation, to buy the underlying security at a specified price for a certain, fixed period of time. Until its expiration, the owner of the call option can exercise the right to purchase the stock from the seller of the call option, at the strike price. At, or prior to maturity, if the option is in-themoney, the call option buyer s profit potential is the difference between the security s price and the option s strike price at exercise, less the amount paid for the option. If the stock price is higher than the strike price at expiration, the option will be inthe-money when exercised and the seller will have to deliver the stated number of shares at the strike price. On the other hand, if the option is outof-the-money, meaning the stock price is below the strike price at expiration, the option will expire worthless and the seller will not have to deliver any stock. In both cases, the seller will benefit from the option premium received at the time the calls are written. A covered call is one where the seller, or writer, of the option holds an equivalent amount of the underlying security. By selling, or writing, a call option, the seller receives income in the form of an option premium. The option premium of a covered call, coupled with any dividends already being paid by the security, generates income for the seller. The seller s profit potential is the premium received from the sale of the call option and the increase in share price, up to the option strike price. Because a stock s price is not static, option prices will be impacted by stock price movements. 1

4 THE MECHANICS OF GETTING STARTED Working with his or her financial advisor, the client should evaluate if the CSO Strategy for generating incremental income on concentrated wealth is appropriate to help meet his or her investment objectives. The client and the advisor will then decide the number of shares to commit to the Strategy and the yield objective. Rampart will use ROMS to provide a hypothetical illustration that presents the potential yield alternatives of implementing the Strategy. In addition to the illustration, Rampart will be helpful in explaining the Strategy in more detail. Once the yield objective is communicated to Rampart by the advisor, Rampart will utilize ROMS to determine the initial call option that is optimal and the number of contracts to write against the position. Typically, the call option will be the closest available strike above the current price of the underlying stock. The number of contracts sold will be determined by the yield objective that is selected by the client and his or her advisor. Based on the yield objective, there will be a price where the underlying security is fully written against, which may limit additional upside price participation. 2

5 HYPOTHETICAL ILLUSTRATION GENERATED BY ROMS The chart below illustrates the trade-off between potential yield from option sales and potential stock appreciation. The bars and left axis represent the potential yield available at various Target Prices. For example, if the target yield is 1.99%, the Target Price selected is 210, there is the potential of 1.99% estimated annual cash, while still allowing for a potential 7.27% appreciation in stock price. Estimated Annual Cash from Option Sales reflects an estimate, based on various assumptions, of potential annual income from selling options using the CSO Strategy. The cash estimate is displayed with different Target Prices for one year from Price Date. The lower the Target Price, the greater the opportunity risk and, therefore, the greater the Estimated Annual Cash Flow. The sloping line and right axis represent the potential appreciation from the current stock price to the Target Price. The higher the Target Price, the lower the opportunity risk and, therefore, the smaller the Estimated Annual Cash Flow. The position simulation table shown below is customized to the equity position held by a client and illustrates a hypothetical first option trade that Rampart would execute to begin the strategy. The sample option trade is one of several trades that are anticipated over a year. Throughout the strategy, Rampart expects to close the existing option position and write new option positions. Rampart will only have one short call option outstanding at any point in time. Available shares of concentrated stock position. Date of the stock price. Amount of option premium per contract the seller can expect to generate from the first trade. Expiration date of the option in the sample trade. Opening (first) option position Ticker. Price at which the buyer of the option may exercise his or her right to buy stock from the seller of the option. Target Price Closing stock price on the price date. Number of days until the option expires in the sample trade. Recommended initial call ratio based on the yield objective and other inputs, as calculated by ROMS. Amount by which the hypothetical Target Price is above the current market price of the stock. Estimated Annual Cash Flow (net of estimated fees and expenses) based on a $210 Target Price. The estimated annual cash from option sales shown is calculated from the price of a one-year option having a strike price equal to the Target Price. In practice, Rampart will not trade an option with duration of one year. The price of the one-year option is a theoretical price and serves as a benchmark for our strategy implementation (through management, we seek to exceed the income generated from a passively written one-year option). Net estimates reflect approximate commissions (0.15%) and management fees (0.35%). Cash estimates do not include the cost of closing open options positions. The illustration is only an estimate of possible results from participating in the CSO and there can be no assurance that returns from the CSO will be the same as, or similar to, the returns depicted in the hypothetical illustration. The returns cited might be achieved only if the parameters described can be duplicated and there is no certainty of doing so. Supporting documentation is available upon request. Further notes on the calculations in this illustration can be found on page 8 of this brochure. 3

6 MONITORING THE YIELD Once Rampart is managing the account, it is the responsibility of the client and the advisor to communicate any changes in the yield objective to Rampart. Prior to making a change in yield objective, the client should consider the potential benefits and risks of any modification. If the client and the advisor decide to increase the yield objective, then the result may be a reduction in the upside capital appreciation potential of the underlying stock position. Once a position is fully written against, the appreciation potential of the stock will be limited to the highest strike price of the option contracts that have been written. Additional upside potential can be achieved by the addition of more shares or by repurchasing some of the outstanding contracts. If the client and the advisor decide to decrease the yield objective, the result may be an increase in the upside capital appreciation potential of the underlying stock position. Rampart can be helpful in reviewing yield objective changes with the client and the advisor. 4

7 THE CONCEPT OF DYNAMIC HEDGING If the stock price rises during the implementation of the strategy, Rampart will continue to roll the option strike price higher by buying (closing) any old contracts and selling (opening) a larger number of new contracts to meet the yield objective. If the stock price rises and the position is 100% written against, additional capital appreciation may be achieved by reducing the yield objective. If, conversely, the stock price declines in subsequent option expiration periods, a smaller number of new, lower strike price contracts will be sold, thereby covering fewer shares. Should the stock price experience a substantial decline at which point fewer contracts are written, it may become difficult to meet the original yield objective. The yield can then be raised by reducing the potential capital appreciation of the underlying stock. The client and the advisor will have the opportunity to review changes to the yield objective with Rampart. If the concept of earning additional income from concentrated stock in your portfolio appeals to you, talk to your financial advisor about the Rampart Concentrated Stock Overlay Strategy. 5

8 POTENTIAL TAX CONSEQUENCES Clients subscribing to the Concentrated Stock Overlay ( CSO ) Strategy should be willing to liquidate (sell) some or all of the concentrated stock under certain circumstances. The sale of stock will produce tax consequences for U.S. taxpayers. Each option transaction also produces a tax consequence. Prior to initiating the CSO Strategy, each client should discuss this Strategy with his or her personal tax advisor to determine how the option transactions and any sales of underlying stock will affect his or her tax situation. Each option transaction also may result in certain adverse U.S. federal income tax consequences to the client. If, however, the market price of the stock becomes greater than the client s selected Target Price for the stock, subsequent call strike prices sold may be less than the current stock price (an in-the-money strike price call option). In particular, writing an option with respect to a stock that the client owns with a strike price that is less than the current market price of the stock may result in (i) the application of some or all of the straddle rules; (ii) the loss of eligibility for the lower rates generally applicable to qualified dividend income with respect to dividends received on the stock; and (iii) the application of the constructive sale rules. The straddle rules and loss of eligibility for the lower rates applicable to qualified dividend income may also apply to an option written with respect to a stock that the client owns with a strike price that is greater than the current market price of the stock if the option has a term of one year or longer. The application of the straddle rules could, among other things, (i) defer the client s recognition of realized losses in respect of the transactions; (ii) cause the suspension or forfeiture of the client s holding period in the stock (making it more likely that a gain on a future sale of such stock would be taxed at the higher rates applicable to short-term capital gains); and (iii) defer the client s deductions in respect of certain costs (including interest expense) related to the transactions. The application of the constructive sale rules would generally require the client to recognize any unrealized gain in respect of the stock as if it were sold for its fair market value, even though the client has not actually sold the stock. If the client maintains a yield objective that results in the fully written position at a price above the current stock price, option contracts written pursuant to the CSO Strategy generally will not be sold with a strike price that is less than the current stock price. If, however, the stock price is greater than the client s yield objective and a fully written position, a call option will be written with a strike price less than the current stock price (an inthe-money call option). Under such circumstances, the client should also consider other actions to avoid having an in-the-money option written (in order to minimize the likelihood of a constructive sale), for example by (i) depositing cash into the account to fund the repurchase of options; (ii) allowing for the assignment of shares or directing the Financial Advisor to sell a portion of the shares subject to the Strategy; or (iii) adding shares. The client should consider the potential adverse tax consequences addressed herein and discuss them with his/her financial and tax advisors when selecting the yield objective for the stock, and considering how best to react to changes in the stock price, including considering whether to modify the yield objective, permit the sale of Strategy assets, or take other actions. RISK CONSIDERATIONS RELATED TO THE CSO STRATEGY Option trading is not suitable for all investors. This brochure must be either accompanied or preceded by the booklet Characteristics and Risks of Standardized Options which can be found at: The CSO Strategy is an option income Strategy designed to continue for at least one year and therefore may not be suitable for clients with shorter investment horizons. Clients participating in the CSO Strategy will select a yield objective prior to initiating the Strategy. The yield objective is an important factor, as clients will not participate in gains in the price of their stock above the price level where the position is 100% written. The client is responsible for the selection of the yield objective for the entire duration of the Strategy. Clients may have to liquidate (sell) some or all of their concentrated stock in certain circumstances. If the stock price appreciates beyond the price where the stock is fully written, the cost to buy back the short call options will increase. Once this occurs, it may become difficult to obtain the desired yield objective. If the CSO Strategy is terminated early, a client may be required to pay a substantial amount of cash to close out option positions before they expire. 6

9 RISK CONSIDERATIONS (continued) There is no assurance that income generated will exceed the cost to close out open option positions. The cost to close out open option positions may exceed the cash generated from the CSO Strategy and result in a loss to the client. The client s stock may be the subject of an acquisition for cash. If the client s stock is acquired as part of a cash takeover, it will no longer be possible to continue with the CSO Strategy. Under these circumstances, the client will be required to close outstanding options at a cost which may exceed the cash generated by the CSO Strategy. FREQUENTLY ASKED QUESTIONS What communications will I receive about my account? Quarterly reports from Rampart will be sent at the request of the advisor. How are the shares of my concentrated position tracked? Shares allocated to the CSO Strategy are segregated in a subaccount held at the client s custodian. Who is responsible for maintaining the yield objective? It is important to emphasize that Rampart manages the Strategy for the client in accordance with the client s instructions with respect to the yield objective. Rampart does not select or makes changes to the yield objective, nor will Rampart take a view on the underlying stock. Each client should consult his or her financial advisor and personal tax advisor when selecting the yield and considering changes to it. Changes to the yield will not be effective until they are submitted to Rampart in writing, bearing the client s signature. Is the yield objective guaranteed? The annualized cash flows are not guaranteed. They are projections, which depend upon many assumptions, including stock price, implied volatility, dividend yield, and interest rates, all of which are subject to change. As a consequence, the actual results will vary from the initial projections related to the selected yield objective. What is an option assignment? An option assignment is a notification from the Options Clearing Corporation (OCC) to a clearing member that the owner of an equity call option has exercised the right to call away (buy) stock at the strike price. For equity options, assignments are made on a random basis by the OCC and communicated to the firm where the client s shares are held. What happens if an assignment occurs? At the time of an option assignment, as seller of the call option, the client must deliver shares of the underlying stock. It is the client s choice to deliver either shares currently owned or shares purchased in the market specifically for delivery. Unless otherwise notified in writing by the client, Rampart will purchase stock on the client s behalf for delivery against any assignments. This enables the client to maintain the cost basis of his or her original stock position. The cost of purchasing stock in the market for delivery against the assignment may exceed the proceeds received from the assignment of shares and concurrent sale of new options, thereby creating a debit in the client s account. Will the cost of the buy back of the current option position always be offset by the sale of the new option contracts? In certain environments, there may be trades that are not cash-flow positive. It is the client s responsibility to provide the cash to close existing option positions when that cost exceeds the cash received from the sale of new options. For this reason, clients may wish to maintain a certain level of cash in their accounts to facilitate the ongoing CSO Strategy. How do I exit the Strategy? A client may exit the Strategy at any time by notifying Rampart in writing. In order to terminate the Strategy, clients are responsible for instructing Rampart to buy back open option positions, unless it is decided by the client that the financial advisor will manage the open position going forward. The cost to terminate the Strategy at any time is the cost to close out any open option positions. Can the Strategy be run on vested, unexercised in-themoney employee stock options? If the CSO Strategy is established against vested, unexercised in-the-money employee stock options, a client will be required to maintain eligible collateral at all times. Such collateral shall be subject to liquidation if it becomes necessary to satisfy any obligation arising from the calls written by Rampart on the client s behalf. 7

10 IMPORTANT INFORMATION The Concentrated Stock Overlay is a dynamic call option Strategy managed on a discretionary basis by Rampart Investment Management, an SEC registered investment adviser. This brochure is intended to describe generally how the Concentrated Stock Overlay Strategy and the ROMS service work, but it is not a complete description of Concentrated Stock Overlay Strategy or ROMS, or how Rampart performs its investment management responsibilities. Transaction costs may be significant in this Strategy, as it may involve multiple commission charges. Past performance is not a guarantee of future results. Supporting documentation for any claims, comparisons, recommendations, statistics, or other technical data will be furnished upon request. RAMPART FEE SCHEDULE CONCENTRATED STOCK OVERLAY For stated fees and minimum account size requirements, contact Rampart Investment Management for a copy of its Form ADV Part 2A. Fees and minimum account sizes are negotiable. NOTES ON CALCULATIONS (i) The returns in the hypothetical illustration on page 3 of this brochure represent the potential appreciation to Target Price, calculated as: (Target Price/Hypothetical Stock Price)-1, and expressed as a percentage. The hypothetical stock price refers to the closing stock price on the price date (in this example, 7/28/2014). (ii) The yields estimated annual cash from option sales are calculated using the Black-Scholes options pricing formula, a model used broadly by options market practitioners to value options. In simplest terms, In dollar value, the estimated annual cash from options sales (gross) is equal to Call Contracts x a multiplier x Call Price, where Call Price is a hypothetical one-year call price (using Black-Scholes), calculated by setting the strike price equal to the Target Price and a exercise date one year in the future. Interest rates, estimates of future volatility of the underlying stock, and dividend yield (based on historical measurements) are other required inputs to the model. Call contracts is shares/multiplier, using a standard option contract multiplier of 100 (i.e., each options contract is written on 100 shares of the underlying stock). As a percentage of an estimated portfolio value, the annual yield from option sales (gross) is equal to the estimated annual cash from options sales (gross) divided by the initial value of the portfolio (shares * hypothetical stock price). For net estimates, the calculations above are repeated with deductions for commissions and management fees. 8

11

12 RAMPART INVESTMENT MANAGEMENT COMPANY, LLC Located in Boston, Massachusetts, Rampart is a registered investment adviser and an affiliate of Virtus Investment Partners. Rampart offers specialized investment services to a broad spectrum of institutional and high net worth clients. Since its inception in 1983, the company has continuously expanded and enhanced its computer modeling and analytical infrastructure to capitalize on opportunities in the financial markets on behalf of its clients. One International Place Boston, MA P F E Copyright Rampart and ROMS are registered trademarks of Rampart Investment Management Company, LLC.

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