The Essential Investment Strategy

©2012 Brookstone Capital Management, LLC. All rights reserved. 1172012

Where do you think we’re headed?History Shows that the market typically moves in cycles. In the past 105 years, there have been three bull markets and three bear markets. The chart shows that we may have entered a bear market.

Value of the Dow Jones Industrial Average for 105 Years (1906-2011)

Bull

Bear

18 Years

5 Years25 Years

11 Years17 Years

17 Years

1906-1924 1925-1929

1930-1954 1955-1965 1966-1982 1983-1999 2000-?

What do investors want?

Not to lose money

Hope to get or stay rich

Banish fear of being poor

Leave money to kids and or spend money in retirement

How will you get there?

Adding new managers that will enhance your current mix of investments and

supplement them during an economic cycle when

traditional investments do not work.

How will you get there?

Typically, investors have used three strategies to get there:

1. Asset allocation2. Market timing3. Buy and hold

Diversification works…Asset Class Examples Using Vanguard Mutual Funds

Timeline goes from top of the Tech Bubble through the bear market of 2000-2002 and recovery to the peak in October 2007

S&P500

Pacific Index

REIT Index

Small Cap

Total Bond Index

European Index

Emerging Markets

until it doesn’t…

S&P500

Pacific Index

REIT Index

Small Cap

Total Bond Index

European Index

Emerging Markets

Asset Class Examples Using Vanguard Mutual FundsAfter October 2007, equities marched in relative unison.

Bonds offered the only significant diversification.SMARToption

Find Non-Correlated AssetsCorrelation Sphere

Traditional investment assets correlate to “1” in this area

Hedged Equity

Market timing• The idea is to move money to

bonds and cash when the market is going to go down

OR• Tactically move between asset

classes during different cycles in the economy

• Timing the market involves calling it right twice, not just once, and that's nearly impossible

Market timing• Most investors tend to let the competing

emotions of fear and greed dictate their investment decisions

• This leads to the tendency to invest after a significant increase in prices and sell during down periods, the opposite of buying low and selling high.

Market timing• This phenomenon has been widely

documented, included in a 2003 Dalbar Study*

• It shows that the average investor stayed invested in equity funds for less than 3 years, buying when stocks went up and selling when the going got tough

*2003 Dalbar, Inc., “Quantitative Analysis of Investment Behavior”.

Market timing

The end result was that investors earned an

average of 2.57% from 1984 to 2003, a

hair below inflation of 3.14%, and far short

of the 12.2% annual gain on the S&P 500 for the same period

Market timingThe record on professionals timing the market is just as abysmal.

•The Hulbert Financial Digest* has tracked what would have happened if every year an investor put his money into the prior year’s top performing market timing newsletter.

•Over 21 years the result would have been an annualized loss of 31.4 percent a year.

•In the real world, that’s equivalent to investing $10,000 in January 1981 and finding that all you have left at the end of 2002 is $2.32.

*Mark Hulbert, Hulbert Financial Digest, http://www.fundadvice.com/FEhtml/PsychHurdles/0304b.html

Market timing

The Bottom Line: It is very difficult to time the market successfully!

Buy and Hold Investors

American Airlines1980 to January 12, 2012

$4.44

$8$13.62

$20.87

$36.13

$2.34

$37.05

$0.32

Buy and Hold Investors

Eastman Kodak1962 to January 12, 2012

1972$66

1987$68

1996$80

2009$2.96

1/2012$0.52

Buy and Hold Investors

Microsoft2000 to January 12, 2012

April 3, 2000$32.53 January 23, 2012

$25.70

Buy and Hold Investors

If you bought and held a 60/40 portfolio* (stocks/bonds), what it would have done…

e.g. 2008

30%

OR

If you bought the S&P 500 in 2000 and held it through 2011

You would be about even

*Lipper Diversified Growth and Income Index

Are there other financial tools I can use to protect and grow wealth?

THE STRIKING PRICE | SATURDAY, JANUARY 8, 2011By STEVEN M. SEARS

Using options to manage the risk of a downturn may be a good idea.

How to Collar a Black Swan

“…pension funds and other institutional investors …can no longer rely solely on macro-economic analysis to adjust portfolios. They have to be cognizant of tail risk and risk management on an ongoing basis. The idea of tail risk, essentially that the unexpected will happen from time to time, is one of the key traits of the modern stock market”.

Joann Hill, ProShares Head of Investment Strategies (2010 IMN Superbowl of Indexing keynote presentation).

“alternative strategies that include options add value to a portfolio and outperform traditional strategies in risk reduction”

What are other Institutional investors saying?

“portfolio managers that do not use options can not adequately protect against market risk”.

James E. Keohane, Healthcare of Ontario Pension Plan Senior Vice-President (2010 IMN Superbowl of Indexing presentation).

How Options Work

Options are:Contracts to either BUY or SELL a specific investment at a specific price

The purchase price of an option is called the PREMIUM – you pay for

this if you exercise your option or not.

Options:The contracts establish a specific price called the STRIKE PRICE at which the contract may be exercised

OPTIONS have a shelf life –

Also called an expiration date, which is the latest date you can “exercise” you option or close out your position

There are two types of Options

CALLS and PUTS

CALL = BuyThe purchase of a call option gives the owner the right but not the obligation to BUY 100 shares of the underlying security at the STRIKE price on or before the expiration date.

The buyer has the right but not the obligation to BUY the shares.

The seller of the option does have the obligation to sell the shares to the buyer.

PUT = SellConversely, the purchase of a put option gives the owner the right but not the obligation to SELL 100 shares of the underlying security at the STRIKE price at anytime before the expiration date.

In this case the seller of the put is required to buy the security at the strike price at the buyer’s request.

Buyers of options

Including both puts and calls spend money.They pay the premium.

Including both puts and calls collect money.They collect the premium.

Seller of options

3 Ways SMARToption Uses Options

1. Buy long-term puts

2. Sell short-term covered calls

3. Sell short-term puts

PUT OptionsPut options are usually purchased as protection against falling stock prices. You pay the premium upfront so that if the underlying stock falls below the strike price, your potential loss is limited.

This protective put works like an insurance policy.

PUT OptionsIf you buy a put option on the S&P 500 (SPY):

You pay some money upfront, and you have the right to sell SPY at a certain price, no matter how much SPY declines. If SPY goes below your strike price, the value of you put will increase. The more the SPY falls, the higher your put will be worth.

You can sell the put for a profit anytime before the expiration date.

If the SPY stays above the strike price, you still can sell the put anytime before the expiration date, but for less than what you paid.

The Covered Call A strategy in which an investor sells or “writes” a call option contract while at the same time owning an equivalent number of shares of the underlying stock or index fund, like SPY.

The stock or index fund is generally held in the same brokerage account from which the investor writes the call, and fully collateralizes, or "covers," the obligation conveyed by writing a call option contract.

This strategy is the most basic and most widely used strategy combining the flexibility of listed options with stock ownership.

The Covered Call • If you sell a covered call on the SPY, you collect

some money upfront, and you have the obligation to deliver your shares of SPY if it hits the strike price.

• If SPY stays below the strike price, you get to keep the premium you collected.

• If SPY approaches the strike price, instead of waiting for your shares of SPY to be “called away” you can buy the calls back and close the position.

PUT OptionsIf you sell a put option on the SPY: You collect the premium immediately adding cash to you account, and you have the obligation to buy shares of SPY if it hits the strike price.

If SPY stays above the strike price, you get to keep the premium you collected

If SPY approaches the strike price, instead of being forced to buy SPY at that price, you can buy the puts back and close out the position.

Are options risky?

Not any more risky than buying a stock is risky.

It’s the investment strategy that can significantly lower risks, not the options themselves.

When correctly applied and actively managed they can be tailored for specific purposes and market conditions.

Are options risky?

When incorrectly applied or left unmanaged, these strategies can expose investors to unacceptable losses.

In the past when these strategies failed, they made headlines in the news.

Options ended up with the blame instead of the investment strategy.

Are options risky?

► OCC is a participant in every options transaction, serving as the intermediary between buyers and sellers.

► You do not deal with any person on the other side of the transaction, you are dealing with the OCC

► OCC issues, guarantees and clears all option trades placed on the U.S. options exchanges.

► Ensures that all of the rules involved in the sales transactions will be followed and that each side will perform as promised.

The Options Clearing Corporation (OCC)

The use of exchange-listed options has been growing at a phenomenal rate.

*2010 Options Industry Council Benchmark Study

In the last ten years trading volume has increased by nearly 500%, with more than 3.8 billion contracts traded in 2010.*

500%

1.Generate income

2.Hedging

3.Diversification

4.Locking in profits

Why should you have options in your portfolio?

How SMARToption works

A two-pronged approach that mathematically minimizes large losses in your portfolio

Hedged Equity Strategy

+ Proprietary Monthly Trading Strategy

How SMARToption works

SMARToption

Basket IEquity + Hedge/Downside

Protection

Basket IIMonthly Options Trading

Consists of:• S&P 500 exchange traded fund• a put option to minimize risk

The option portion of Basket I is specifically designed to limit a portfolio’s exposure to falling markets. The option component is an investment similar to an insurance policy on your house. The deductible for this policy (amount you pay for protection) is specifically chosen to limit (not eliminate) losses.

Basket I

If Market is Put is

Basket I100% of client money

Hedge / Downside Protection

(10-15% of client money)Long Put Option: Bought at or near

the money – sized to give you defined risk of 7-10% maximum downside.

Equity(85-90% of client money)

S&P 500 Exchange Traded FundSPY

By investing in a broad-based index fund such as SPY, it automatically reduces company/ sector risk through diversification across multiple companies and even markets (e.g.US/International).

Buying and holding the index ETF also eliminates futile attempts in market timing and/or predicting future values of individual stocks.

This strategy is possible because protection from significant declines does not come from prophesy but from the Basket I hedge.

Basket I

Basket IIWe sell out of the money

Puts and Calls against our positions in Basket I

(Brings cash into the account)

1. Sell Put on SPY

2. Sell Call on SPY

When puts and calls are sold, they generate premium or ‘income’ that is added to your account.

This independent income generating component of the strategy generates income to the account in all market conditions. 

Basket II

This income also helps to offset the cost of the hedge used in Basket I. It incorporates multiple specified adjustment and liquidation points to minimize risk and maximize the frequency and size of monthly returns.

These adjustment and liquidation points were extensively back-tested and then proven through implementation over the past 14 years.

Basket II has been quantitatively designed in type, size, & frequency to provide market-neutral returns.

Basket II

Basket II – Selling out of the moneyPuts and Calls against our positions in Basket I

1. Sell a put

2. Sell a call

1. Put strike price

2. Call strike price

S&P 500 current market price

Sweet spot over the market. Take profits on both the put and call if market remains within

sweet spot

If the market moves down toward put strike, we have a stop order to buy back

the put here

If the market moves up toward call strike, we have a stop order to

buy back the call here

Put in the $ Call in the $

Basket II

Adjustments

Original Put strike price

Original Call closed for profit

S&P 500 original price

Sweet spot over the market moves with

the market

If the market moves down toward put strike, we have

adjustment points that enable us to stay in the trade and increase the

probability of success to over 80%

If the market moves down toward put

strike, we will take profits on the original call and sell a new call which brings in

more premium

S&P 500 new price

New Call

Basket I - 100% of a client’s portfolio is invested in Basket I. 85-90% is invested in SPY equity shares and 10-15% is invested in a hedge through a long-term option on SPY.

SMARToption’s – 2 components

Basket II is an independent income generating component of the strategy which has been quantitatively designed in type, size, & frequency to provide market-neutral returns.*

*Based on past performance

The proof is in the performance.

The Key to SMARToption’s Success

Bull

Bear

Upside Capture has averaged 70% of the S&P 500 returns in bull markets

Downside Capture has averaged 5% of the S&P 500 returns in bear markets

100%

-100%

70%

-5%

SMARToption captures substantial upside in bull marketsand minimizes losses in bear markets!

Market CyclesSMARToption vs S&P 500*

SMARToption* S&P 500

Bull 1 49.23% 71.17%

Bear 1 24.41% -37.61%

Bull 2 53.61% 82.85%

Bear 2 -3.60% -37.00%

Bull 3 44.50% 48.97%

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

*Since inception, 1997, gross of fees

Cumulative Value vs. MarketBull and Bear Market

Cumulative ValuesSMARToption vs S&P 500*SMARToption* S&P 500

Bull 1 $149,232 $171,169

Bear 1 $185,660 $106,792

Bull 2 $285,192 $195,269

Bear 2 $274,925 $123,019

Bull 3 $397,156 $183,254

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

*Since inception, 1997, gross of fees

The Key to SMARToption’s SuccessDown Years for the S&P 500*

From 2000-2002, hedging protected the downside and actually provided a profit!

In 2008, when S&P 500 lost 37%, we were down only 3.6% before fees!

Prevent large losses!

8.42%

-9.10%

12.97%

-11.89%

12.22%

-22.10%

-3.6%

-37.00%

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

*Since inception, 1997, gross of fees

Reduces Risk Increases Returns Risk vs. Return

1997- 2011

Risk – Standard Deviation

An

nu

aliz

ed R

etu

rn

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

Client in SMARToption since 1997

Aggregate Growth vs. Indices*1997 – 2011

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.012/97 12/99 12/01 12/03 12/05 12/07 12/09

SMARToption

S&P 500

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

*Net of fees

If you are in the market and not hedged when the market drops 40%, it’s a lifestyle change!

Take the Good with the bad

Client in SMARToption since 2003

Aggregate Growth vs. Indices*2003 – 2011

2.6

2.4

2.2

2.0

1.8

1.6

1.4

1.2

1.0

SMARToption

S&P 500

1/04 1/05 1/06 1/07 1/08 1/09 1/10 1/11

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

*Net of fees

The proof is in the performanceSMARToption vs S&P 500

Cumulative Returns 1997 – 2011

SMARToption (Gross of Fees)

S&P 500

297%

83%

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

The proof is in the performance

SMARToption (Gross of Fees)

S&P 500

$183,254

$397,156

Growth of $100,000Cumulative Returns 1997 – 2011

Important Notes: All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients

should not assume, that future performance will be comparable to past performance.

GIPS®

In the past, investors had great difficulty obtaining meaningful comparisons of accurate investment performance data.

Making apples-to-apples comparisons of investment performance was problematic, and the existence of country-specific guidelines for performance presentation further complicated matters.

Are a big deal!

There was a need for a practitioner-driven set of ethical principles and a standardized, industry-wide approach to calculating and reporting investment results.

The foundation for the GIPS standards was first established in 1987.

To develop one globally accepted set of standards, the GIPS committee began work in 1995 to get them formally endorsed

Are a big deal!

After an extensive period of public comment, the AIMR Board of Governors (now known as the CFA Institute) formally endorsed the GIPS standards in February 1999.

Since their introduction, the GIPS standards have gathered momentum with investment management firms worldwide adopting these voluntary, ethical standards for calculating and presenting historical investment performance.

Organizations in 34 countries sponsor and promote the standards.

Are a big deal!

• GIPS compliant firms voluntarily go beyond legal reporting requirements to demonstrate a commitment to open, honest, and ethical practices.

• To claim compliance, an investment firm must demonstrate adherence to comprehensive and rigorous rules governing input data, calculation methodology, composite construction, disclosures, and presentation and reporting.

• GIPS compliant firms must have their data audited and verified by a qualified third party firm.

Are a big deal!

Investments that adhere to GIPS® should assure investors that the firms’ investment performance

is complete and fairly presented.

Are a big deal!

Fees

Fees

How can we do this?

SMARToption will have a SET FEE SCHEDULE!

Fees will be deducted quarterly for a total of 2.25% annually.

The FEE SCHEDULE is not-negotiable and cannot be altered.

You will not see any other fees taken out of your account

NO transaction fees

NO ticket charges

NO trading costs

Wrap fee structure

A wrap fee structure is where both: ● Asset management fees for advisory services● Transaction fees for execution services

are wrapped into a single fee charged to the client.

In a Wrap Fee arrangement, a client’s costs are the same regardless of the number of transactions in an account.

Total Expense StructureThe underlying vehicle is an S&P 500 ETF, which has a very low expense ratio of 0.0945%.

TOTAL ANNUAL FEE: 2.25% + 0.0945 = 2.3445%

Quarterly Fee ScheduleAsset Valuation

Investment Advisory Fee

Investment Consultant Fee

Total Fee Quarterly

Total Fee Annually

$60,000 - $500,000 0.3125% 0.25% 0.5625% 2.25%

$500,001 - $1,000,000 0.2875% 0.2125% 0.5% 2.00%

Over $1,000,000 0.25% 0.1875% 0.4375% 1.75%

Minimum: $60,000

It’s all about transparency► With fee-based money management you

know what you are paying for upfront.► Your advisor’s interest is in-line with yours.

The better your investments performs the higher the fee they will receive.

► When compared to other fee structures for comparable products, this fee schedule is quite reasonable.

Expense Ratios► According to the Investment Company Institute (ICI) the average

expense ratio for a mutual fund that is actively managed is 1.45%. ► This includes fees paid to the manager of the fund, administrative

costs, marketing and distribution services. ► The expense ratio is not deducted from your account, rather the

investment return you receive is already net of the fees.► Plus on top of that you will also pay your advisor a fee. Typically

1%-2%.► Assuming 1.5% (advisory fee) + 1.45% (average expense ratio

mutual fund) this brings the total cost of owning a mutual fund to about 3.0%, not to mention trading and transaction fees that may apply!

This Putnam Fund has an expense ratio of 1.58% + 1.50% Management fee + Other transaction costs $$$

► The underlying holdings in the account consist of an ETF (SPY) and options (puts and calls), all of which are highly-traded, marketable securities. Therefore, the strategy is 100% liquid at all times as we could simply sell these securities if needed at any time.

► To optimize the strategy, we would strongly discourage you from taking funds out of the SMARToption Model, so that you can receive the full benefit of the model’s performance.

Liquidity

► SMARToption is positioned as the core “growth” strategy and so short-term liquidity should be addressed elsewhere in your financial plan.

Liquidity

Technology

Technology AdvantageOne of the most sophisticated and highest performing strategies in the industry, SMARToption requires advanced technology to be able to implement across thousands of accounts.

►We have developed a proprietary electronic system which facilitates implementation, monitoring, and adjustment of the strategy. ►By specifically designing our interface consistent with our strategy, we have dramatically simplified implementation and management activities such as trading, new account investment, reporting, etc.

OperationsTrading Systems

● Broker-Specific Trading and Order Management Systems● Proprietary/Custom Trader Software

Monitoring/Coverage● Continuous oversight /monitoring during trading hours● Multiple traders monitoring positions and executions (redundancy) ● Automated email/phone notifications on market price, adjustment &

liquidation points

Back Office/Reporting● Captools (GIPS® Compliant) performance software

Industry Recognition

SMARToption’s Recognition and Awards

5 Star Rated for 3 Years2008-2009-2010

SMARToption’s Recognition and Awards

#1Market-Neutral Manager For 1 and 5 Years*

*August 22, 2011

SMARToption’s Recognition and Awards

3, 5, 7 and 10 YearsTop 1% of Large Cap Money Managers

for Returns* *As of 2010

SMARToption’s Recognition and Awards

3, 5, 7 and 10 YearsTop 1% of Large Cap Money Managers

for Low Risk* *As of 2010

SMARToption’s Recognition and Awards

3 Years(among the top 10 performers in its peer group of several thousand large cap money managers as

maintained by Informa Investment Solutions)

PSN TOP Gun

GIPS® compliant (verified through end of 2010) demonstrated returns over 14 years.

SMARToption’s Recognition and Awards

In bull, bear and flat market conditions

Performance is GIPS® Verified

Core Equity

SMARToption as a Core Holding

Satellite Positions (such as Real Estate, Commodities,

Bonds, Emerging

Markets etc.)

SMARToption

SMARToption as a Large Cap Holding

SMARToption

SMARToption as an Alternative Holding

SMARToption

Performance results are presented in U.S. dollars and are gross-of-actual-fees and trading expenses and reflect the reinvestment of dividends and capital gains. Actual fees may vary based on, among other factors, account size and custodial relationship. No current or prospective client should assume future performance of any specific investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may cause the performance results of your portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client's investment portfolio. Historical performance results for market indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Swan Wealth Advisors, “the Firm”, claims compliance with the Global Investment Performance Standards (GIPS®). To receive a complete list and description of the firm’s composites and/or a presentation that adheres to the GIPS® standards, please contact the Firm at the address listed.

©2012 Brookstone Capital Management, LLC. All rights reserved.