Exceed Investments

Let us be your Options Expert

collar

Common Misconceptions About Option Strategies: What Advisors Need to Know

Options can be a powerful tool for financial advisors looking to enhance client returns, manage risk, and potentially exit a concentrated position in a tax-efficient manner. However, many advisors hesitate to incorporate options due to widespread misconceptions. In this article, we’ll debunk some of the most common myths about option strategies and provide insights into how advisors can effectively leverage them for their clients.

 

Misconception #1: Selling Options is Too Risky

One of the most persistent myths is that selling options is inherently dangerous. While certain strategies—such as selling naked calls—carry significant risk, selling options strategically against equity holdings can enhance portfolio returns while maintaining controlled risk exposure. Strategies such as covered calls and cash-secured puts allow advisors to generate consistent income while maintaining defined risk limits. The key is understanding the risks and structuring trades appropriately to align with investment objectives.

 

Misconception #2: Options Are Only for Speculators

Many advisors assume that options are tools meant only for aggressive traders looking to make quick profits. While this may be true with regard to speculatively buying options, option-selling programs can play a crucial role in conservative portfolio management. Advisors can use option overlays to generate additional income through covered call strategies or sell puts to enter stock positions at more favorable prices. When used correctly, selling options can provide an additional layer of risk management rather than being purely speculative.

 

Misconception #3: Options Are Too Complex for Clients to Understand

It’s true that options involve additional layers of complexity compared to traditional stock investing. However, that doesn’t mean they are incomprehensible or unusable. Many advisors successfully incorporate option-selling strategies by educating clients on their benefits and risks in a straightforward manner. Explaining how a covered call generates additional income makes these concepts more digestible for clients. Clear communication and proper risk management help bridge the knowledge gap and make more options accessible. Advisors who don’t have the requisite knowledge or time required to implement these strategies can hire an outside expert like Exceed.

 

Misconception #4: Selling Options is a High-Volatility Strategy

While strategies such as covered calls or collars can be very beneficial in volatile markets, selling options is not solely a high-risk, high-volatility play. Even in low-volatility environments, selling options can provide ongoing income and improve portfolio efficiency. Covered call strategies work best when markets are flat or slowly rising, but they can also be profitable in strong bull markets. By structuring trades correctly, advisors can benefit from different market conditions, not just volatile ones.

 

Misconception #5: Options Are Too Expensive to Implement

Some advisors believe that options are costly due to margin requirements or potential losses. However, many option-selling strategies involve well-defined risks that can be managed with proper portfolio allocation. Covered calls, for example, do not require additional capital beyond owning the underlying stock, and cash-secured puts ensure that sufficient cash is available to buy the underlying stock if assigned. With low-cost option trading now widely available, cost barriers are lower than ever.

 

Final Thoughts

Misconceptions about options have led many financial advisors to overlook their potential benefits. However, when used strategically, selling options can be a valuable tool for generating income, managing risk, and enhancing tax efficiency. By debunking these common myths and educating both themselves and their clients, advisors can take full advantage of what option-selling strategies have to offer. Instead of viewing options as overly risky or complex, advisors should see them as a flexible instrument that, when properly implemented, can improve client outcomes and portfolio resilience.

 

 

 

 

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. No strategy can prevent all losses or guarantee positive returns. Options trading involves risk and does not guarantee any specific return or provide a guarantee against all loss. Clients must be approved for options trading at the custodian holding their assets, and not all retirement accounts are permitted to trade options. Transaction costs and advisory fees apply to all solutions implemented through Exceed and will reduce returns.

Nervous About Your NVDA Gains? A Solution to Both Protect and Participate with No Cash Outlay

NVDA has been one of the biggest beneficiaries of the recent AI craze, as the company has added 90% to its market capitalization year-to-date and a staggering 251% year-over-year. It’s now the third-largest company in the world with a market cap of about $2.4T, trailing only AAPL ($2.6T) and MSFT ($3.2T). If you or a client have been fortunate enough to ride this rally, you’re likely very pleased by the recent performance but also potentially have excess exposure to shares of this single, volatile company. As we’ve discussed in previous blogs, companies with the highest market capitalization have historically underperformed broad-market indices over longer timeframes. 1https://exceedinvestments.com/where-are-those-top-10-companies-now-nineties-focus/ 2https://exceedinvestments.com/where-are-those-top-10-companies-now-millennium-focus/ 3https://exceedinvestments.com/where-are-those-top-10-companies-now-2010-focus/ This isn’t to say that NVDA is going to underperform the broad market going forward, but history has shown that the upside outliers are scarce.

As a shareholder of a now-concentrated NVDA position, an investor faces the tradeoff of holding a portfolio with elevated embedded volatility that is exposed to greater downside risk versus selling a portion of their NVDA holding to diversify into a balanced market portfolio. However, rebalancing out of a highly-appreciated stock will likely come at the cost of a big tax bill. Thankfully, there is a solution using options that allows investors to hedge downside risk while also participating in significant potential share appreciation, and greatly reducing volatility while deferring and seeking to minimize capital gains taxes.

A collar is an option overlay strategy that involves selling an upside call against an existing stock position and using the proceeds from that sale to purchase protective puts that limit downside to a predefined level. A “zero-cost collar” is one of the more popular option strategies and involves matching the premium collected from the sale of the call to the cost of purchasing puts, thus requiring no or very little cash outlay, inclusive of the cost of executing the trade. There is an implicit cost of potential foregone upside in the event the stock rallies above the sold call option strike, but collars can even be structured as a net credit to the investor if so desired, resulting in a cash inflow.

 

 

Option prices are dynamic and are partially driven by demand for bullish exposure (calls) versus bearish exposure (puts). When stocks rally sharply, calls are generally more “expensive” relative to puts because of excess investor demand to buy those calls and place bullish bets on continued appreciation. Contrarily when stocks sell off sharply, investor sentiment can shift dramatically and drive excess demand for put options. This is known as skew and is a common metric followed closely by option traders. The recent sharp rally in NVDA has driven call prices significantly higher than puts, creating the potential to use a collar overlay on an NVDA stock position very efficiently. At this point in time, you can sell very “expensive” calls and buy relatively “cheap” put options, maximizing the tradeoff between potential upside appreciation and downside protection via option collars. The chart below depicts the difference in implied volatility of calls versus puts, with the difference in implied volatility of 25-delta (out of the money) options plotted on the Y-axis. When the reading is positive, puts are relatively more expensive than calls, and when the reading is negative calls are more expensive than puts. The put-call skew reading hit an extreme low a couple weeks back, indicating that calls were at their most expensive level relative to puts at any point over the past three years. While this extremely low reading has reverted somewhat higher since then, the current level remains well below long-term averages.

 

 

NVDA closed at 925.61 on 3/26, and the options market has a volatility expectation of +/- 43.4% for NVDA shares between now and June 20, 2025, 450 days from today.4Using the midpoint of 6/20/25 option prices as of the market close on 3/26/24 for an at-the-money straddle This means that the options market is currently pricing NVDA to close within a range either 43.4% higher or lower from here, or between about 524 and 1327 by 6/20/25. Options can often be wrong about the realized volatility over a period, but we like to use this as a baseline expectation of outcomes over a certain timeframe to give a general idea how to best structure these trades.

Assuming the options market is correct about its volatility expectation, you can currently sell the 6/20/25 1340-strike call on NVDA for about $110 per contract and buy the 790-strike put for about the same price. What this means is that a holder of an NVDA stock position with this collar overlay can fully participate in 44.8% share upside between now and 6/20/25, while limiting downside risk to a maximum of 14.7%. Perhaps the investor would like a little more upside potential and less downside protection or vice versa – below is a list of currently available collars that can be implemented at close to zero cash outlay. These strategies are fully customizable, so the NVDA holder can choose exactly how much potential upside or downside protection they desire and structure the trade accordingly. As you can see, the potential upside is generally a multiple of maximum downside by about a factor of 3 – this is a result of the excessive skew in NVDA call options that currently exists.

 

 

Options trading is nuanced and complex, with the opportunities that exist largely a product of the market environment. Recent trends in NVDA options have created what we view as a compelling opportunity for an investor currently sitting on a concentrated NVDA position. This collar overlay will significantly reduce volatility, allow the holder to still participate in some level of potential appreciation, and defer having to rebalance the portfolio and pay capital gains taxes. Contact us for a consultation as to how you can use the recent developments in the NVDA options market to your advantage.

 

 

 

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. No strategy can prevent all losses or guarantee positive returns. Options trading involves risk and does not guarantee any specific return or provide a guarantee against loss. Clients must be approved for options trading at the custodian holding their assets, and not all retirement accounts are permitted to trade options. Transaction costs and advisory fees apply to all solutions implemented through Exceed and will reduce returns.

 

The Effect of Rising Interest Rates on Option Strategies

In 1973, economists Fischer Black and Myron Scholes published “The Pricing of Options and Corporate Liabilities,” which was the birth of the modern option pricing model that is still today’s gold standard for valuation. The formula isn’t perfect and has some limitations, but for the most part it’s withstood the test of time. We’re not going to get too into the weeds with the complex mathematical formula that they created, but if you want to learn more about it you can here.

 

What’s important to glean from the Black-Scholes Model are the factors that have a first-order effect on option prices and the extent of how changes in those inputs alter the underlying option price. There are 5 basic inputs that determine the price of an option:

  1. Underlying Asset Price – The price of the stock, index, or ETF. Higher-priced assets generally have higher option prices on a dollar basis (but not a percentage basis).
  2. Implied volatility – The market’s expectation of the future volatility of this asset1Not to be confused with historical volatility, which measures how volatile a security has been in the past. Many people use a combination of historical volatility, upcoming known events, and general market activity to triangulate a reasonable implied volatility estimate. . Higher expected volatility leads to higher option premiums and vice versa.
  3. Time to Expiration – The greater the time to expiration, the higher the theoretical price of an option (wider range of outcomes over longer timeframes), all else equal.
  4. Option Strike Price – The price at which the security can be purchased (call option) or sold (put option) by the option holder prior to or at the maturity date (expiration date)2We are assuming a US readership. “American” options can always have their right exercised while “European” options can only be exercised at maturity..
  5. The current Risk-Free Interest Rate3Dividends are incorporated into this rate – risk-free interest + dividend yield creates an effective forward rate for an underlying security. A hard to borrow security would result in a higher borrowing cost, which would affect the forward rate. This cost is also incorporated into the “rate” component of the formula. – Theoretical rate of return that an investor would expect on an investment with zero risk. The proxy for this rate is the yield of a Three-Month U.S. Treasury Bill.

 

 

Many option traders are very familiar with 1-4 on this list, but the interest rate component is oftentimes ignored. It’s no secret that rates have risen dramatically over the past two years, especially at the short end of the curve.  The graph below depicts the 3-month U.S. Treasury Yield going back to 1990. The rate of ascent from the bottom in rates in early 2022 to present day is the fastest ever, and the current yield of 5.49% is near its highest level over the past 23 years.

 

 

All else equal, a higher risk-free interest rate leads to higher call option prices and lower put option prices.  Buying options is a way to get leverage and requires less initial investment than owning or shorting shares, though an option buyer must recognize the risk that they may lose all their investment if the underlying security is not above the call strike or below the put strike on the day of maturity. An investor can purchase call options instead of shares to express a bullish view and then use the difference in capital required to invest elsewhere. With interest rates much higher now than they were in early 2022, the opportunity cost of buying shares has increased. Money that would be tied up owning stock can now be invested “risk free” at more than a 5% return. We see the opposite of this phenomenon with put options – traders can buy put options to express a bearish view instead of shorting shares, but shorting stock becomes more profitable as interest rates increase. When you short a stock, the broker will pay interest on the cash that the short sale generated. Since the potential interest earnings are now much higher than before, put options become less valuable.

 

Let’s look at a hypothetical situation involving stock XYZ. We’ll assume that (1) the stock is $100 per share, (2) the strike price of both the call and put option are 100(at the money), (3) the options expire in 90 days, (4) the company doesn’t pay dividends, and (5) the volatility of XYZ shares is 20%. The risk-free rate in January 2022 was around 0.053%, so we’ll use that as a baseline.  Given those inputs, the theoretical call price is 3.97 and the put is 3.95.

 

Now let’s assume that nothing has changed except it’s now 10/31/23 and the risk-free rate is 5.49%. Using those inputs, the theoretical call price becomes 4.65 and the put is 3.41 – a 17% increase in the call option price and nearly a 14% decline in the value of the same put option!

 

 

Let’s take this a step further and look at out-of-the-money options, which are more rate sensitive than at-the-money options. Using the same assumptions as before and looking at 10% and 20% out-of-the-money options instead of at-the-money options, the changes in the option prices were staggering. The theoretical price of the 10% out-of-the money call rose by 27% and the 20% out-of-the money call rose by 39% merely from the difference in the risk-free rate between January 2022 and now.  Additionally, the price of 10% out-of-the-money put option declined by 23%, and the 20% out-of-the-money put saw a theoretical drop of 34% by adjusting only one variable. All else equal, the farther out of the money an option is, the more its value is affected by changes in interest rates.

 

Investors can capitalize on these recent market trends and use them to their advantage. It may not make as much sense now as it did in January 2022 to buy a call option (for multiple reasons), but you can flip that dynamic and use the elevated premiums to write covered calls and generate additional income on your stock holdings. With lower relative put premiums now than in 2022, hedging stock positions via buying puts or collars may be more logical now than before.

 

Options trading is nuanced and complex, with the opportunities that exist largely a product of the market environment. The dramatic spike in interest rates over the past couple years has changed the landscape and creates the potential for higher income generation and lower hedging costs now than before. Contact us for a consultation as to how you can use these developments to your benefit.

 

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. No strategy can prevent all losses or guarantee positive returns. Options trading involves risk and does not guarantee any specific return or provide a guarantee against loss. Clients must be approved for options trading at the custodian holding their assets, and not all retirement accounts are permitted to trade options. Transaction costs and advisory fees apply to all solutions implemented through Exceed and will reduce returns.

Where are Those “Top 10” Companies Now? – “2010” Focus

“Top” companies can seemingly do no wrong during their ascent. Whether filtered by top US companies by market cap or fastest growing over the last decade, these companies tend to be household names with a ton of caché. Right now, the top US company by market cap is Apple (AAPL). The fastest growing for the last decade (2010s) is Netflix (NFLX). Some of the luster has already caught up to Netflix as competitors have filled the gap. Apple, though, still seems to dominate. Will that be the case in five years? 10 years? When a fifty-something is ready to retire and dip into their nest-egg?

The only sure thing in investing is uncertainty, but maybe we can learn something from history. How have the “Apples” and “Netflixes” of the past performed over time? Today, let’s look back to 2010 and see if there are any important lessons for investors.

Below is a list of the ten largest companies by market capitalization as of 1/4/2010, and their performance since. These return numbers include dividend reinvestment and consider a hypothetical $100,000 investment in each security using closing prices on 12/31/2009. The ending value is as of 12/31/2022. We’ve also provided information on the results of the SPDR S&P 500 ETF Trust (SPY), representing large-cap US equities, and the Invesco QQQ Trust (QQQ), an ETF with holdings of mostly large-cap stocks from the Nasdaq 100, during the same period. The performance shown in this table is for illustrative purposes only and is not intended to represent the performance of Exceed Advisory or any of its clients.

The hypothetical performance shown in the table above is for illustrative purposes only and is not intended to represent the performance of any Exceed Advisory portfolio or of Exceed as a firm.

 

This decade was a great time to be invested in equities, as the economy was recovering from the Great Financial Crisis with the aid of quantitative easing and historically low interest rates.  Most of the damage from 2008-2009 was repaired in a matter of a couple years, and the era of dominance by technology stocks was underway. Despite this backdrop and a raging bull market, investments in only a small percentage of these companies would’ve yielded superior performance to a passive index investment – only AAPL and MSFT were the outliers.  Investments in GOOGL, BRK.B or JPM would’ve resulted in performance similar to that of their respective indices, while the remaining five companies on this list significantly underperformed the broad market.  In a previous blog we looked at the bear-market period from 2000-2010 and it showed that being diversified was critical for loss mitigation and volatility reduction. This has also held true during strong bull markets – very few investors are able to pick stocks that are long-term outperformers, and from the list above there was only a 20 percent chance that an investment in any of these names would’ve resulted in material outperformance. Choosing to hold a concentrated portfolio raises its risk profile, which in turn increases the potential for underperformance versus a diversified market portfolio.

Below is the current list of the ten largest U.S. corporations. We will continue to look at different slices of time in future blogs as we did above, but the theme remains consistent – historically, most of the biggest companies have underperformed the broad market over long periods of time.  It seems unfathomable that any of these companies could be poor investments going forward, but history suggests otherwise. That said, it’s also true that past performance isn’t a guarantee of future results, so we don’t know for sure what the future will bring. We do, though, think caution is warranted when assuming that today’s top performers will continue to be tomorrow’s top performers.

The solution to combat a concentrated portfolio of mega-cap stocks is simply to reduce position sizes and rebalance into a diversified market portfolio.  Multiple studies have shown that concentrated portfolios often underperform over long time periods, and the optimal portfolio decision is to rebalance and reduce volatility and exposure. 1Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189 2Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf  If you or your clients have concentrated positions with significant tax liability in any of the above companies, Exceed Investments can help. Exceed’s tools can be implemented to hedge large investments, and in many cases reduce them to a desired level without having to pay capital gains tax.  Contact us for a consultation.

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. Hedging does not prevent all losses or guarantee positive returns. Transaction costs and advisory fees apply to all solutions implemented through Exceed.

Tax Lessons Learned From Tesla

The past few years for Tesla (Ticker: TSLA) have been anything but mundane. Shares of the equity experienced a meteoric rise from mid-2019 to late 2022, with a trough-to-peak rally of over 3400% in a little over three years. However, after its parabolic ascent the shares declined by about 75% in a little over a year.

 

Opinions on the company are as polarizing as they come – some believe that it’s a cash-burning vortex destined for bankruptcy, while others are convinced Elon Musk can walk on water and TSLA is set to take over the world. Musk’s recent Twitter fiasco removed a lot of the sparkle from his image, and that shift in sentiment can be seen in Tesla’s recent performance.  There was always an embedded “Elon premium” in the shares, as believers shunned fundamentals because of the CEO’s rockstar image. Is it possible that there is now an “Elon discount?”

Early investors in the company experienced a financial windfall between mid-2019 and November 2021, but many were likely caught up in the hype, which would limit a potentially prudent taking of some profit. Aside from human emotions, the most likely reason that a buy-and-hold investor refused to reduce their TSLA position after its rapid rise was the associated tax liability with selling shares. Let’s look at a hypothetical situation involving an early investment in TSLA…

Assume a buy-and-hold investor with a $1M portfolio invested 10% of their capital in TSLA shares at an average price of $20 (split adjusted for today’s prices) at the end of 2018, and the remaining 90% of their capital was invested in a diversified market fund. For simplicity’s sake, in this example we’ll use the SPDR S&P 500 ETF trust (symbol SPY), an exchange traded fund (ETF) that aims to track performance of the S&P 500 index. So, on 1/2/2019 this hypothetical portfolio consisted of $100,000 in TSLA shares and $900,000 in SPY shares. The table below shows the performance of the Tesla and SPY positions, using end-of-year values. This illustration also assumes a 20% capital gains tax rate.

 

As you can see the Tesla position quickly grew into a substantial percentage of the total portfolio holdings. From the investor’s perspective, this is obviously a very good thing because it means that the TSLA position was appreciating rapidly. However, this rapid appreciation creates other problems associated with buy-and-hold investing.  Multiple studies have shown that holding a concentrated portfolio generally leads to underperformance. 1Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. ”The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189  2Bernt Arne Ødegard, “The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?” Finance Research Letters Volume 6, Issue 2. https://doi.org/10.1016/j.frl.2009.01.003 3Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf

In addition to the heavy concentration risk, the total portfolio volatility grew substantially. TSLA has a five-year monthly beta of 2.03, meaning that it’s more than twice as volatile as “The market.” As a result, total portfolio volatility grew by nearly 50 percent over the first three years. Elevated levels of volatility that lead to underperformance can be detrimental to risk-adjusted performance metrics like Sharpe and Sortino Ratios.

It’s easy to look back and wonder why an investor didn’t rebalance their portfolio after such a gigantic move higher by TSLA, but hindsight is always 20/20. At its peak at the end of 2021, the theoretical tax liability associated with the TSLA holding was approximately three times the initial investment amount, and nearly 30% of the initial portfolio value! Upon the liquidation of shares, this tax liability can be seen as an immediate loss of portfolio value.

Rapid ascents by companies like this aren’t anything new. History is littered with similar examples of companies that quickly rose to prominence, only to fall back to earth. A few that immediately come to mind are Yahoo, Dell Computer, Zoom, Meta, Netflix, Nokia, and Blockbuster Video. Generally speaking, companies that rise the most during bull markets may depreciate rapidly during market downturns. It’s imperative that investors harvest gains and periodically rebalance their portfolios in order to avoid substantial drawdowns.

The good news is that there are solutions to these common problems. Options are often (and rightly) viewed in a negative light among retail investors, as they can be very risky and lead to substantial losses. Options are complex and can be intimidating to even the most seasoned investor. What many people don’t realize, though, is that options can also be powerful tools for tax optimization and hedging within a portfolio. When correctly implemented, an option overlay strategy may completely eliminate tax liability on certain concentrated positions, while simultaneously hedging downside risk. There are of course transaction costs involved, as well as advisory fees in the case of an overlay strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial positive effect on long-term capital appreciation.

If you or a client are dealing with how best to address the tax liability and downside risk concerns that often accompany concentrated positions, feel free to reach out to the team at Exceed Investments. Members of Exceed’s Portfolio Management Team have over 38 years of professional options experience and are well-versed in the tax code. These strategies can be tailored to fit specific investment goals and satisfy immediate needs. When executed properly, these option overlay strategies may reduce or eliminate tax liability, lower risk, and help you and your clients achieve their financial goals in an efficient manner.

 

Contact us for a consultation.

 

 

 

This blog post is for informational or educational purposes only and is not intended as investment advice.  Any discussion of investment strategy or approach is intended only to illustrate investment concepts and in no case does the discussion represent Exceed Advisory’s investment performance or the results of any Exceed Advisory portfolio.  We provide investment advice only to clients and only after entering into an advisory agreement and obtaining information concerning individual needs and objectives. We think the information provided is accurate, but accuracy is not guaranteed. All investing in securities involves risks, including the risk of loss.

 

Where Are Those “Top 10” Companies Now? – “Millennium” Focus

“Top” companies can seemingly do no wrong during their ascent. Whether filtered by top US companies by market cap or fastest growing over the last decade, these companies tend to be household names with a ton of caché. Right now, the top US company by market cap is Apple (AAPL). The fastest growing for the last decade (2010s) is Netflix (NFLX). Some of the luster has already caught up to Netflix as competitors have filled the gap. Apple, though, still seems to dominate. Will that be the case in five years? 10 years? When a fifty-something is ready to retire and dip into their nest-egg?

The only sure thing in investing is uncertainty, but maybe we can learn something from history. How have the “Apples” and “Netflixes” of the past performed over time? Today, let’s look back to 2000 and see if there are any important lessons for investors.

Below is a list of the ten largest companies by market capitalization as of the start of 20001As of the close of trading on 12/31/1999, and their performance since. These return numbers include dividend reinvestment and consider a hypothetical $100,000 investment in each security on the close of trading for 19992As of the close of trading on 12/31/1999. The ending value is as of 12/31/2022. We’ve also provided information on the results of the SPDR S&P 500 ETF Trust (SPY), representing large-cap US equities, and the Invesco QQQ Trust (QQQ), an ETF with holdings of mostly large-cap stocks from the Nasdaq 100, during the same period. While it’s not possible to invest directly in an index, index returns are widely used to reflect the performance of “markets” overall.

 

The hypothetical performance shown in the table above is for illustrative purposes only and is not intended to represent the performance of any Exceed Advisory portfolio or of Exceed as a firm.

 

This decade was an especially difficult time in markets, as the tech bubble burst in 2000 and led to a catastrophic selloff in equities over the next two years.  Markets recovered and recouped most of the losses from the tech bubble over the subsequent five years, but that rally led right into the financial crisis of 2008. Stocks fell precipitously once again before bottoming in early 2009, but this period was essentially a lost decade for investors. It’s evident from the table above that this era of investing was fraught with risk, as even the most established companies weren’t insulated from the crisis. Of the 10 largest companies by market capitalization in 2000, only investments in MSFT and XOM would’ve yielded returns in excess of market indices.  Of the other 8 companies on this list that underperformed the broad market, only two generated dollar returns of at least half of that of a similar investment in SPY.  Investments in three of these companies (AIG, C, and GE) would’ve resulted in significant capital losses over this twenty-two-year period.  Market crises create the potential for big losses in individual names, and this period was no exception. It’s especially important to have a diversified portfolio during such times, and history will likely repeat itself in the future on a long enough timeframe.

Below is the current list of the ten largest U.S. corporations. We will continue to look at different slices of time in future blogs as we did above, but the theme remains consistent – historically, most of the biggest companies have underperformed the broad market over long periods of time.  It seems unfathomable that any of these companies could be poor investments going forward, but history suggests otherwise. That said, it’s also true that past performance isn’t a guarantee of future results, so we don’t know for sure what the future will bring. We do, though, think caution is warranted when assuming that today’s top performers will continue to be tomorrow’s top performers.

The solution to combat a concentrated portfolio of mega-cap stocks is simply to reduce position sizes and rebalance into a diversified market portfolio.  Multiple studies have shown that concentrated portfolios often underperform over long time periods, and the optimal portfolio decision is to rebalance and reduce volatility and exposure.3Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. The Journal of Wealth Management Winter 2022, jwm.2022.1.189; https://doi.org/10.3905/jwm.2022.1.189 4Bernt Arne Ødegard, “The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?” Finance Research Letters Volume 6, Issue 2. https://doi.org/10.1016/j.frl.2009.01.003 5Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf  If you or your clients have concentrated positions in any of the above companies, Exceed Investments can help. Exceed’s tools can be implemented to hedge large investments, and in many cases reduce them to a desired level, often without having to pay capital gains tax.  There are of course transaction costs involved, as well as advisory fees in the case of an options strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial effect on long-term capital appreciation.

 

Contact us for a consultation.

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. Hedging does not prevent all losses or guarantee positive returns. Transaction costs and advisory fees apply to all solutions implemented through Exceed.

 

 

 

Where Are Those “Top 10” Companies Now? – “Nineties” Focus

“Top” companies can seemingly do no wrong during their ascent. Whether filtered by top US companies by market cap or fastest growing over the last decade, these companies tend to be household names with a ton of caché. Right now, the top US company by market cap is Apple (AAPL). The fastest growing for the last decade (2010s) is Netflix (NFLX). Some of the luster has already caught up to Netflix as competitors have filled the gap. Apple, though, still seems to dominate. Will that be the case in five years? 10 years? When a fifty-something is ready to retire and dip into their nest-egg?

The only sure thing in investing is uncertainty, but maybe we can learn something from history. How have the “Apples” and “Netflixes” of the past performed over time? Today, let’s look back to 1990 and see if there are any important lessons for investors.

Below is a list of the ten largest companies by market capitalization as of the start of 1990[1], and their performance since. These return numbers include dividend reinvestment and consider a hypothetical $100,000 investment in each security on the close of trading for 1989[2].  The ending value is as of 12/31/2021. We’ve also provided information on the results of the S&P 500 Index (SPX), representing large-cap US equities, and the Nasdaq 100 Index (NDX), representing the 100 largest non-financial companies listed on the Nasdaq stock exchange, during the same period. While it’s not possible to invest directly in an index, index returns are widely used to reflect the performance of “markets” overall.

[1] As of the close of trading on 12/29/1989

[2] As of the close of trading on 12/29/1989

The hypothetical performance shown in the table above is for illustrative purposes only and is not intended to represent the performance of any Exceed Advisory portfolio or of Exceed as a firm.

 

What’s immediately evident is the underperformance by most of these companies versus the broad market.  Only three of these ten stocks outperformed the S&P 500 over this 32-year period and the level of outperformance was very modest.  Of the seven companies that underperformed the market during this time, only CVX and KO were able to produce dollar returns of at least half of what a similar hypothetical investment in the S&P 500 index would have produced.  Annualized returns of only a few percent below the market may not seem like much on the surface, but the differences can be staggering when compounded over multiple decades.

Exxon Mobil Corp (XOM) is the only company on the list from 1990 that is also on today’s top-ten list. The oil giant is currently the tenth-largest U.S. company, with a market capitalization of about $443B.  After underperforming for years, shares of XOM doubled from early 2020 to the end of 2021. The rally has continued this year as the Russia-Ukraine conflict rages on and puts upward pressure on energy prices.  The pending global economic slowdown could potentially bring energy prices and equities under pressure, and any resolution or de-armament between Russia and Ukraine would likely lead to easing energy prices across the board. There are currently multiple risk factors that could reduce investment demand in XOM and bring its share price and market capitalization back closer to longer-term equilibrium levels.

So why did most of the largest ten companies underperform the broad market over this period? There’s obviously no explicit or simple answer, though multiple hypotheses may make a case for market efficiency.  Perhaps this phenomenon is just the result of the dreaded “Law of large numbers.” Companies that achieve a certain size and level of market dominance eventually are capped by macroeconomic factors, and their growth rates normalize.  The ten companies listed above weren’t built on fads or short-term economic trends, but many from the 2000s and 2010s were. Perhaps investors gravitated toward the newer “sexy” investments and shunned these present-day value names in hopes of achieving outsized returns.  Economic trends have always been cyclical, and this creates boom and bust periods where a deemed great investment multiple years ago can become the exact place where you do not want to be invested when the tide goes out.

Below is the current list of the ten largest U.S. corporations. We will continue to look at different slices of time in future blogs as we did above, but the theme remains consistent – historically, most of the biggest companies have underperformed the broad market over long periods of time.  It seems unfathomable that any of these companies could be poor investments going forward, but history suggests otherwise. That said, it’s also true that past performance isn’t a guarantee of future results, so we don’t know for sure what the future will bring. We do, though, think caution is warranted when assuming that today’s top performers will continue to be tomorrow’s top performers.

 

 

The solution to combat a concentrated portfolio of mega-cap stocks is simply to reduce position sizes and rebalance into a diversified market portfolio.  Multiple studies have shown that concentrated portfolios often underperform over long time periods, and the optimal portfolio decision is to rebalance and reduce volatility and exposure.[3],[4],[5] If you or your clients have concentrated positions in any of the above companies, Exceed Investments can help. When executed properly, Exceed’s option tools can be implemented to hedge large investments, and in many cases reduce them to a desired level, often without having to pay capital gains tax. There are of course transaction costs involved, as well as advisory fees in the case of an options strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial effect on long-term capital appreciation.

Contact us for a consultation.

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives.

 

 

[3] Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. The Journal of Wealth Management Winter 2022, jwm.2022.1.189; https://doi.org/10.3905/jwm.2022.1.189

[4] Bernt Arne Ødegard, “The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?” Finance Research Letters Volume 6, Issue 2. https://doi.org/10.1016/j.frl.2009.01.003

[5] Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.”  https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf

Tax Avoidance Gone Wrong – The Rise and Fall of Facebook

Facebook’s IPO was one of the hottest ever.  The company was growing at an astounding rate as social media went fully mainstream, and everyone wanted in on the action. Facebook went public on May 12, 2012 at $38 per share, and after some initial weakness the stock price experienced a meteoric rise over the next nine years. Despite FB declining more than 50% in the months immediately following its initial offering, a buy-and-hold investor who purchased shares on the day of its IPO saw a return of 10 times their initial investment between 2012 and 2021.

Fast forward to present day and the situation looks much different for holders of Facebook (now Meta) shares. Increasing competition from TikTok, government regulation, market saturation, and a deteriorating macroeconomic environment have led to a 75% peak-to-trough decline over the past thirteen months. The paper gain that existed for these IPO investors wilted from 900% to less than 150% in the span of a little over a year. Life comes at you fast.

It’s easy to look back and wonder why someone holding a concentrated position in Facebook shares didn’t sell or at least reduce their position after such a big rally, but there are monetary and psychological reasons why investors struggle to dispose of appreciated assets. Human emotions and greed aside, the primary reason investors hesitate to sell stock after a big gain is capital gains tax. Let’s take a look at the math by illustrating a hypothetical investment in FB shares on its initial public offering…

Assume an investor allocated 10% of their $500,000 portfolio to FB shares at the IPO price of $38, and the remaining 90% of their capital was invested in a diversified market fund. For simplicity’s sake, in this example we’ll use the SPDR S&P 500 ETF trust (symbol SPY), an exchange traded fund (ETF) that aims to track performance of the S&P 500 index. So, on 5/18/12 this hypothetical e-portfolio consisted of $50,000 in FB shares and $450,000 in SPY shares. The table below shows the performance of the Facebook and SPY positions, using end-of-year values. This illustration also assumes a 20% capital gains tax rate.

 

As you can see the Facebook position quickly grew into a substantial percentage of the total portfolio holdings. While this is obviously a good thing, it creates a myriad of other problems that can arise in buy-and-hold investing. Portfolios with concentrated positions are a recipe for underperformance. Studies have shown that not only do concentrated positions raise the overall risk and volatility profile of a portfolio, but historically those portfolios have also exhibited suboptimal returns.¹ Heavy concentration in a single-stock position creates the potential for catastrophic losses, which can take many years to recoup. Lastly, managing a concentrated portfolio is more difficult than simply rebalancing a “standard” diversified portfolio of stocks and bonds.

Below are the 2022 returns and position values for the hypothetical portfolio described above.  You’ll notice that the portfolio is underperforming the S&P 500 by over 11% this year, and this can be attributed solely to the concentrated position in META shares. Adding insult to injury, the equity underperformed the broad market over virtually every timeframe this year, and at an elevated level of volatility. META has a five-year monthly beta of 1.32, compared to a market beta of one. Not only did shares of META underperform the market on a gross basis, but even more so on a risk-adjusted basis. Poor returns by assets with higher risk profiles can be detrimental to risk-adjusted performance metrics like Sharpe and Sortino Ratios.

 

So why didn’t our theoretical investor simply sell some shares to reduce risk? Most likely, they wanted to avoid paying a 20% capital gains tax. Based on a 20% capital gains rate, the theoretical taxes owed if the investor had liquidated the position at the end of 2021 were more than 150% of the initial investment and nearly 4% of the total portfolio value!  On the face of it, deferring this sale seems logical, as that tax can be seen as an immediate loss. However, calculations suggest that investors who choose to liquidate their concentrated positions and pay capital gains tax are making the optimal decision. Reducing volatility has a first-order effect on the long-run growth and preservation of wealth.¹

The good news is that there are solutions to these common problems. Options are often (and rightly) viewed in a negative light among retail investors, as they can be very risky and lead to substantial losses. Options are complex and can be intimidating to even the most seasoned investor. What many people don’t realize, though, is that options can also be powerful tools for tax optimization and hedging within a portfolio. When correctly implemented, an option overlay strategy may completely eliminate tax liability on certain concentrated positions, while simultaneously hedging downside risk. There are of course transaction costs involved, as well as advisory fees in the case of an overlay strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial effect on long-term capital appreciation.

If you or a client are dealing with how best to address the tax liability and downside risk concerns that often accompany concentrated positions, feel free to reach out to the team at Exceed Investments. Members of Exceed’s Portfolio Management Team have over 38 years of professional options experience and are well-versed in the tax code. These strategies can be tailored to fit specific investment goals and satisfy immediate needs. When executed properly, these option overlay strategies can reduce or eliminate tax liability, lower risk, and help you and your clients achieve their financial goals in an efficient manner.

 

¹ Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. ”The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189

 

This blog post is for informational or educational purposes only and is not intended as investment advice.  Any discussion of investment strategy or approach is intended only to illustrate investment concepts and in no case does the discussion represent Exceed Advisory’s investment performance or the results of any Exceed Advisory portfolio.  We provide investment advice only to clients and only after entering into an advisory agreement and obtaining information concerning individual needs and objectives. We think the information provided is accurate but accuracy is not guaranteed. All investing in securities involves risks, including the risk of loss.