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A tactic traditionally known as the 90/10 strategy enables retail and institutional investors to achieve two goals simultaneously: capital preservation and potential appreciation from a bullish market move. This method involves the purchase of either long-term (LEAPS) or short-term at-the-money index call options (S&P 500 (options symbol: SPX), S&P 100 (OEX), DJIA (DJX), etc.) with a small portion

A tactic traditionally known as the 90/10 strategy enables retail and institutional investors to achieve two goals simultaneously: capital preservation and potential appreciation from a bullish market move. This method involves the purchase of either long-term (LEAPS) or short-term at-the-money index call options (S&P 500 (options symbol: SPX), S&P 100 (OEX), DJIA (DJX), etc.) with a small portion of a portfolio's capital -- roughly 10% -- and the purchase of low risk cash equivalents with the remaining 90%, thus the name 90/10. The maximum risk is the premium paid for the calls. Also, if the index moves above the break-even index level (strike price plus call price), the index call options allow the portfolio to participate dollar for dollar in a market rally.

For example, let's assume that a conservative investor believes that the upcoming election will favor his/her desired candidate, and thus influence the market (S&P 500) in a positive way. He/she is bullish, but risk averse. He/she has $500,000 in low risk cash equivalent investments, but is willing to invest at least 10% to gain market exposure to express a bullish opinion on the market. To simplify the example commissions and other charges are not included. Be aware! The inclusion of these costs can impact performance.

In order to calculate the proper quantity of S&P 500 index calls required to replicate a $500,000 portfolio, the investors must use the following formula: Number of calls = portfolio value/(index level x multiplier)

Number of SPX calls on April 26, 2004 = $500,000/(1135 x 100) = 4.40 or 5

The SPX call options nearest the S&P 500 index level of 1135 are the 2004 December SPX 1140 calls at $58 each for a total cost of $29,000 (5 x $58 x 100). Please note that the investor purchased 5 contracts because the total cost to replicate a $500,000 is well under 10% of capital. Also, note that the calls have 8 months of time until expiration.

Assume the remaining capital balance of $471,000 is kept in a low risk cash equivalent investment that pays 2% annually for 8 months earning $6,280 or $477,280 total.

The "Portfolio Percent Change" column shows that the maximum loss on this portfolio is 4.54%, which is the premium paid for the index calls minus the interest earned on the cash investments. This occurs if the SPX index level declines or remains constant and the calls expire worthless. Remember, if your view on the market changes before the expiration date, you can sell the call options any time before the day expiration to avoid losing your entire premium.

With any market rally, however, this portfolio of SPX calls plus cash will participate in the market advance. If the market rallies to an index level of 1305, a 15% advance, for example, this cash-plus-calls portfolio increases in value by 11.95%. It is important to note that the maximum loss of the portfolio is also the approximate amount by which the portfolio will under-perform the market if the index level rises. In short, the strategy affords most of the reward without all of the risk.

SPX Level at 1135

To find out more about how options can help you better manage risk or about "The Options Course for Financial Planners & Advisors", please contact Laura Johnson at 1-800-THE-CBOE then press 2 or visit our website at www.cboe.com.


FOR REGISTERED REPRESENTATIVES ONLY. NOT FOR CUSTOMER DISTRIBUTION.

Options involve risk and are not suitable for all investors. For a copy of the Options Disclosure Document, please contact the CBOE at 1-800-THE-CBOE.

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