Trade Derivative Disclosure
SMArtX utilizes derivatives in conjunction with its replication and implementation of the investment strategies of the portfolios offered by the model managers on its Platform. Specifically, it may trade in ETFs, options, futures, options on futures, index options and other derivatives. The technology utilizes derivatives as a way to decrease the difference in performance between the selected Portfolio’s strategy and the account of an investor on the Platform. Our use of derivatives in an Investor’s account is dependent on a number of dynamic characteristics, including the size of the selected portfolio, the size of the Investor’s allocation, the broker the Investor has chosen, the type of brokerage account the Investor has opened, the number of positions in the selected model, the amount of leverage the Investor chooses to utilize and the current market environment. The use of derivatives involves substantial risk of loss and does not guarantee better performance in any market environment.
Options Disclosure
The prices of many derivative instruments, including many options, are highly volatile. Price movements of options contracts are influenced by, among other things, interest rates, changing supply and demand relationships, and trade, fiscal, monetary and exchange control programs and policies of governments, and national and international political and economic events and policies. The value of options also depends upon the price of the securities, currencies or other assets underlying them. An Investor’s account is also subject to the risk of the failure of any of the exchanges on which its positions trade or of its clearinghouses or of counterparties. The cost of options is related, in part, to the degree of volatility of the underlying securities, currencies or other assets. Accordingly, options on highly volatile securities, currencies or other assets may be more expensive than options on other investments.
Put options and call options typically have similar structural characteristics and operational mechanics regardless of the underlying instrument or asset on which they are purchased or sold. A put option gives the purchaser of the option, upon payment of a premium, the right to sell, and the writer the obligation to buy, the underlying security, commodity, index, currency or other instrument or asset at the exercise price. A call option, upon payment of a premium, gives the purchaser of the option the right to buy, and the seller the obligation to sell, the underlying instrument or asset at the exercise price.
If a put or call option purchased in an Investor’s account were permitted to expire without being sold or exercised, the Investor’s account would lose the entire premium it paid for the option. The risk involved in writing a put option is that there could be a decrease in the market value of the underlying instrument or asset caused by rising interest rates or other factors. If this occurred, the option could be exercised and the underlying instrument or asset would then be sold to the Investor’s account at a higher price than its current market value. The risk involved in writing a call option is that there could be an increase in the market value of the underlying instrument or asset caused by declining interest rates or other factors. If this occurred, the option could be exercised and the underlying instrument or asset would then be sold by the Investor’s account at a lower price than its current market value.
Purchasing and writing put and call options and, in particular, writing “uncovered” options are highly specialized activities and entail greater than ordinary investment risks. In particular, the writer of an uncovered call option assumes the risk of a theoretically unlimited increase in the market price of the underlying instrument or asset above the exercise price of the option. This risk is enhanced if the instrument or asset being sold short is highly volatile and there is a significant outstanding short interest. These conditions exist in the stocks of many companies. The instrument or asset necessary to satisfy the exercise of the call option may be unavailable for purchase, except at much higher prices. Purchasing instruments or assets to satisfy the exercise of the call option can itself cause the price of the instruments or assets to rise further, sometimes by a significant amount, thereby exacerbating the loss. Accordingly, the sale of an uncovered call option could result in a loss by the Investor’s account of all or a substantial portion of its assets.
Futures Disclosure
Trading futures is a highly risky strategy. Whenever a particular future is purchased for an Investor’s account, there is a possibility that the Investor’s account may sustain a total loss of its purchase price. The prices of futures are, in general, much more volatile than prices of securities such as stocks and bonds. As a result, the risk of loss in trading futures is substantially greater than in trading those securities. Prices of futures react strongly to the prices of the underlying commodities. The prices of these underlying products, in turn, rise and fall based on changes in interest rates, international balances of trade, changes in governments, wars, weather and a host of other factors that are entirely beyond Smart X’s control and that are very difficult (and perhaps impossible) to predict.
Short Sales Disclosure
We may sell securities in an Investor’s account short. Short selling involves the sale of a security that the seller does not own and must borrow in order to make delivery in the hope of purchasing the same security at a later date at a lower price. In order to make delivery to its purchaser, the seller must borrow securities from a third party lender. The seller subsequently returns the borrowed securities to the lender by delivering to the lender securities it previously owned or by purchasing securities in the open market. The seller must generally pledge cash with the lender equal to the market price of the borrowed securities. This deposit may be increased or decreased in accordance with changes in the market price of the borrowed securities. During the period in which the securities are borrowed, the lender typically retains its right to receive interest and dividends accruing to the securities. In exchange, in addition to lending the securities, the lender generally pays the seller a fee for the use of the seller’s cash. This fee is based on prevailing interest rates, the availability of the particular security for borrowing and other market factors. Theoretically, securities sold short are subject to unlimited risk of loss because there is no limit on the price that a security may appreciate before the short position is closed. In addition, the supply of securities that can be borrowed fluctuates from time to time. An Investor’s account may suffer significant losses if a security lender demands return of the lent securities and an alternative lending source cannot be found.
Leverage Disclosure
When appropriate and subject to applicable regulations and an Investor’s instructions, We will use leverage in the investment program for the Investor’s account, including the use of borrowed funds (“Margin Leverage”) and investments in certain types of options, such as puts, calls and warrants, which may be purchased for a fraction of the price of the underlying securities while giving the purchaser the full benefit of movement in the market of those underlying securities (“Synthetic Leverage”). While such strategies and techniques increase the opportunity to achieve higher returns on the amounts invested, they also increase the risk of loss.
To the extent of purchases of securities with borrowed funds for an Investor’s account, the account will tend to increase or decrease at a greater rate than if borrowed funds are not used. The level of interest rates generally, and the rates at which such funds may be borrowed in particular, could affect the performance of an Investor’s account. If the interest expense on borrowings were to exceed the net return on the investments made with borrowed funds, the use of leverage would result in a lower rate of return than if leverage were not used.
If the amount of borrowings which an Investor’s account may have outstanding at any one time is large in relation to its capital, fluctuations in the market value of its portfolio will have disproportionately large effects in relation to the assets in the Investor’s account and the possibilities for profit and the risk of loss will therefore be increased.
When the market value of a particular open position changes to a point where the margin on deposit does not satisfy maintenance margin requirements, a “margin call” on the customer is made. If the customer does not deposit additional funds with the broker to meet the margin call within a reasonable time, the customer’s position may be closed out. In the event of a precipitous drop in the value of the assets in an Investor’s account, we might not be able to liquidate assets quickly enough to pay off the margin debt, and the Investor’s account might suffer mandatory liquidation of positions in a declining market at relatively low prices, incurring substantial losses. With respect to these trading activities, the Investor’s account and not SMArtX, will be subject to margin calls.
Overall, the use of leverage, while providing the opportunity for a higher return on investments, also increases the volatility of such investments and the risk of loss. Investors should be aware that an investment program utilizing leverage is inherently more speculative, with a greater potential for losses, than a program that does not utilize leverage.