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April 01, 2005
New SRI Managed Account Uses Options to Capitalize on Market Ups-and-Downs
    by William Baue

The socially responsible investment team at Piper Jaffray screens the new Redwood Account, which applies the covered options strategy of Kelmoore Investment Company.


This week, Kelmoore Investment Company introduced the Redwood Account, a managed account that fuses Kelmoore's signature covered options strategy with Piper Jaffray Philanthropic & Social Investment (PSI) Consulting division's expertise in social and environmental screening. With an account minimum of $250,000, the product is geared toward high net-worth individuals who can individualize the accounts to reflect their own values.

For example, they can screen out tobacco, alcohol, or gambling products, nuclear power generators, weapons producers, environmental polluters, and human rights offenders. PSI also offers positive screening, giving preference to companies that promote gender and ethnic diversity, for example.

"We're catering to the client who wants to keep their social and investing philosophies aligned," said Tamara Wendoll, senior executive vice president of marketing and operations at Kelmoore.

What distinguishes this offering from other socially responsible investment (SRI) managed accounts is its strategy of leveraging equity options to generate income.

"It's the only option-writing strategy we know of, which is one of the reasons we partnered with Kelmoore," said Tom Van Dyck, PSI's senior vice president of investments.

Covered options is a sophisticated strategy best understood using an example to illustrate.

"If you buy ABC stock when it's trading at $100 a share, you write an option, which means you give somebody else the option to purchase from you at a certain 'strike' price, let's say $101," Ms. Wendoll told SocialFunds.com. "We could write a call option, which would give somebody else the option to buy from us for say $1.50, so the option will cost them that much per share."

If the stock goes up to $101, then the stock option gets "called."

"For the account holder, it would generate the $1 difference between $100 and $101, plus the $1.50 of the option premium, so together that's $2.50 per share," Ms. Wendoll explained. "Most of them expire worthless, which is the benefit of doing covered options, because generally they want to be able to continue to hold the equities in the account, they don't want that much turnover so they don't want options to be called away consistently."

For those seeking an even more in-depth but easy-to-understand explanation, Kelmoore created a series of comics featuring "Kaptain Kelmoore," a superhero whose mission is to save investors from confusion over equity options.

While most long-term investments ride out minor waves up and down in the market, slowly generating returns as the sea level rises, the Redwood Account capitalizes on market movements.

"The reason the strategy might work well in times like this is the market seems to be in a trading range--it's either down five or up five," Mr. Van Dyck told SocialFunds.com. "When it's in a trading range, they sell options as a way of bringing in income to the account."

"It's not a bad way of getting a dividend boost while the stock market goes sideways," he added. "If the stock market goes up, though, you lose some stock, and you won't get the full appreciation."

Kelmoore has systems in place to minimize this effect.

"Our strategy is really micromanaged--our portfolio managers are monitoring the portfolios all day long," Ms. Wendoll said. "We have an in-house system call Opt-tracker that looks at all the different pricing factors of the options, such as the strike price, the price of the underlying equity, and how price moves during the day."

The Redwood Account focuses on large-capitalization stocks, constituting individualized portfolios of companies screened from a starting universe of the S&P 100.

"As with all Kelmoore products, it will be sold through broker-dealers or pension consultants," said Ms. Wendoll.

 

 
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