Strategy Description

The IncomeShares NVIDIA Options ETP is designed to generate monthly income for investors by using a covered call also known as “buy and write” options strategy. NVIDIA covered call position is created by buying NVIDIA shares and selling the same amount of American style “at-the-money” or up to 5% “out-of-the-money” NVIDIA call options which have one week to expiry and are rolled over on a weekly basis.

In return for the sale of the NVIDIA call options, the fund receives a premium. From the weekly premium received from selling the call options, the ETP pays a monthly yield to investors. The strategy allows the fund to retain upside exposure to NVIDIA’s share price (up to the options strike price) in addition to any dividends (if any).

Understanding Covered Call Strategy

A covered call option strategy is designed to generate additional income from a portfolio. The strategy involves holding a long position in a stock or other financial instrument while simultaneously selling (writing) call options on the same asset.

The primary objective is to earn premium from the sale of the call options, which can provide a buffer against potential future declines in the underlying asset’s price. The potential losses are limited to the downside movement in the underlying asset’s price, less the premium received from writing the call option.

The strategy is considered „covered“ because the option seller already owns the underlying asset, mitigating the risk of having to purchase the asset at a higher market price to fulfil its obligation if the call option is exercised.

FIGURE 1: Covered call pay off diagram :

Covered Call in Different Markets

Covered call writing is most effective in a neutral to moderately bullish market environment, where significant upward price movements are not anticipated. This strategy can enhance portfolio returns through the collection of premia and provide some downside protection. However, the strategy also limits the fund’s upside potential in a strong up trend where the price of the underlying asset could rise significantly above the strike price.

1. Up Trend:In a strongly trending market if NVIDIA share price at expiration is above the strike price, the fund has two options.

a) The fund could keep the premium received from selling the call option and get exercised – i.e. sell NVIDIA shares at the predetermined strike price.

b) However, the fund may find it prudent not to sell NVIDIA shares. In such case the existing options contract could be rolled over in order to avoid delivery.

Rolling Options Forward

Generally, rolling options forward involves allowing options to lapse or closing out an existing call option and simultaneously opening a new call option with a later expiration date and potentially a different strike price. This technique could be used to avoid the sale of the asset when the original call option is approaching or is at expiration, and the underlying price is above the strike price.

2. Down Trend:If NVIDIA declines, at expiration the share price would be below the strike price of NVIDIA’s call option. Therefore, the fund would incur a loss in its shareholdings position, which would be partially or fully offset by the premium received.

3. Within a Trading Range:If NVIDIA stock fluctuates in a narrow range and at expiration the share price is below the strike price, the fund will keep the premium received as well as NVIDIA shares, benefiting from the entire move of the stock. The maximum profit potential from the strategy is if at expiration NVIDIA’s share price is at or close to the strike price of the call option.

Benefits From Covered Calls

Income Generation: The main benefit of a covered call strategy is the potential to generate additional income from selling call options and enhance the product’soverall returns. If the underlying asset price remains below the strike price throughout the life of the option, the fund keeps both the premium and the underlying asset.

Downside Protection: The premium received from selling the call options effectively provides a downside protection against a moderate decline in the underlying asset price. The premium received also lowers the breakeven point on the position and helps to reduce the portfolio volatility.

FIGURE 2: Covered call strategy smooths the volatility

Enhanced Returns in Sideways Markets: In markets trading in a range to moderately bullish trends, covered call can provide consistent returns from the premiums received.

Risks From Covered Calls

Limited Upside Potential: The maximum gains at expiration are limited by the strike price. If the price of the underlying is at the strike price, the covered call strategy reaches its peak profitability. However, if the underlying price increases significantly above the strike price, the covered call strategy would miss out on the full upside potential.

The maximum gain for the option seller if the current price is above the strike price:

Strike Price – Underlying Asset Price + Premium Received

Obligation to Sell:If the price of the underlying assetis above the strike price at expiration, the covered call writer must sell the asset at the strike price.

The covered call writer could select a higher, out-of-the-money strike price and preserve more of the stock’s upside potential for the duration of the strategy. However, the further out-of-the-money call would generate less premium income.

Choosing Out-Of-The-Money vs. At-The-Money Strike Price

If the fund has a bullish view on NVIDIA in the short-term, it could select a call option with a higher, out-of-the-money strike price in order to preserve more of NVIDIA’s upside potential for the duration of the strategy. However, the further out-of-the-money call option would generate less premium income.

If the fund has a negative, neutral or mildly bullish view on NVIDIA in the short-term, it could select at-the-money call option with a strike at or very close to the current share price.

Depending on the overall market conditions, NVIDIA’s trend, short-term price expectations, implied volatility and etc., the fund would choose the most appropriate strike price at the time, while adhering to the covered call strategy.

Glossary:

Call option:A call option is a derivative contract which gives the option buyer the right to buy a specified asset at a specified price during a specified period. Upon exercise of that right, the option seller is obliged to sell the underlying asset to the option buyer.

Strike Price : The strike price or exercise price is the agreed price at which the underlying asset will change hands if the option is exercised. It is the price for which the underlying asset can be bought (in the case of a call option) or sold (in the case of a put option) if the buyer of the option elects to exercise its rights.

In-the-money : A call option is in-the-money if the strike price of the option is lower than the price of the underlying asset.

At-the-money : A call option is at-the-money if the strike price of the option is the same as the price of the underlying asset.

Out-of-the-money : A call option is out-of-the-money if the strike price of the option is higher than the price of the underlying asset.

Premium : The premium is the cost or price of the option. It is the amount paid by the buyer of an option to the seller of an option.

Expiry date : The expiry date of the option (also known as maturity date, exercise date, or declaration date) is the last day on which the option may be exercised.

American style options:American style options can be exercised by the buyer at any time from the date of purchase up until (and including) expiry date.