Using Options to Back Ethical Investment Strategies

Ethical investing involves trading stock options by picking and choosing the companies and businesses that best align with your personal values and beliefs on topics like the environment and social issues. While there are some challenges associated with ethical investing, a growing segment of traders constructs their portfolios around supporting companies that share their worldview.

A versatile financial tool for enhancing these strategies is options contracts which can help investors gain exposure to ethical investments, but also limit the potential risks they might face while trading. This guide will show you how to integrate options into ethical investing while aligning with your personal or organizational values. Keep reading to learn how you can trade in a way reconciled with your principles, values, and beliefs.

Understanding Ethical Investment Strategies

To better understand the concept of ethical investing and the strategies that investors can take, we need to define the term and talk briefly about the challenges that investors and traders might face. These higher-risk investments like ESG and Socially Responsible Investing can be subject to market volatility and can be difficult to diversify, among other challenges.

What Are Ethical Investments?

Ethical investing is about striking a balance between financial and ethical goals. These are the types of investments that support industries that create positive economic, social, or environmental change. Before investors decide on an ethical investment, they usually consider the company’s social or environmental impact.

Ethical investments typically include these popular approaches:

• ESG (Environmental, Social, Governance): This kind of investing focuses on improving financial performance and promoting sustainable practices. The goal is to integrate environmental, social, and governance practices into the investment process.
• Socially Responsible Investing (SRI): This investment strategy focuses on social, ethical, or environmental goals in addition to seeking financial returns. It differs from ESG in that it examines subjective criteria to evaluate each organization rather than use objective criteria the way ESG would.
• Impact Investing: Not only does this form of investing involve generating financial gains, but it also involves making investments that help create beneficial social or environmental effects. Impact investing doesn’t just pertain to stocks and bonds but to other asset classes such as microloans or mutual funds.
• Faith-Based Funds: These refer to ETFs or mutual funds that are managed from a faith-based perspective. They’re rooted in the belief that one’s values and principles should be reflected in their financial decisions. It’s about choosing companies that don’t conflict with their moral or ethical standards.
• Thematic Funds: This mutual fund selects its holdings based on exposure to a larger structural trend that goes beyond the traditional business cycle. Such trends can be technological, societal, or environmental. These investments can diversify risk for investors by trading with companies that are directly involved in a trend.

Challenges in Ethical Investing

What are some of the main chances when it comes to investing in companies or stocks that support your personal values, beliefs, or convictions? There are quite a few challenges you’ll run up against, but the biggest is perhaps the limited investment options!

• No Agreed-Upon Definition: The term “ethical” means something different depending on who you are. There’s a clear lack of a clear definition of what makes an ethical investment, so how these investments would work in practice can vary greatly from one investor to the next.
• No Standardized Reporting Method: Because investment managers could interpret environmental, social, and governance differently from other investment managers, ethical investing reports can often be hard to comprehend and lack consistency.
• Limited Diversification: Because ethical investors like to exclude companies that don’t match their criteria, they have fewer options to choose from, which makes diversifying their portfolios an issue. This leads to lower short-term returns and better returns over time.
• Subject to Market Volatility: Ethical investments can fluctuate greatly based on the broader market. These investments are more designed for the long-term as short-term fluctuations can greatly impact options prices and returns.

Overview of Options Trading

One of the best ways to do ethical investing is to do so using stock options. Let’s run through some of the options trading basics and several of the key concepts and terminology that investors should be familiar with when executing trades on a daily basis.

What Are Options?

Options are contracts that give the buyer the right to buy or sell an asset at a particular strike price by a certain expiration date. Options come with many financial instruments, including stocks, equities, ETFs, and indices. There are two kinds of options that are worth noting:

• Call Options: These options give the buyer the right to buy the underlying stock at a certain strike price by a set expiration date. If you think the stock’s price will increase, it’s a good idea to buy a call option. They are good for portfolio growth but also a great strategy for limiting losses—you can’t lose any more than the premium you paid.
• Put Options: These options give the buyer the right to sell the underlying stock at a certain strike price by a set expiration date. They are best used to guard a portfolio from a decline in value. Put options can also be used to profit from the decline in a security’s price.

What makes options so desirable for online inventors is the flexibility of options for hedging, income generation, and speculation. Investors can use options to limit potential losses in an investment portfolio while maintaining exposure to potential gains (hedging) or profit from movements in the underlying and build a position that would profit if the security behaves the way it’s speculated.

Key Concepts in Options Trading

To fully understand options trading, it’s best to know these key concepts, including the factors that make up an options contract and some of the factors that can affect their value.

• Strike Price: This refers to the price at which an investor can buy or sell an underlying asset through an options contract. It’s the key factor in determining an option’s value and the potential for profit or loss.
• Premium: This is the price paid by the buyer to the seller for the rights outlined in the options contract. The premium reflects the intrinsic value and time value of the option. Together, these two factors make up the option’s total worth.
• Expiration Date: The specific date when an options contract becomes invalid. The holder can no longer exercise the right to buy or sell the underlying asset at the strike price.
• Volatility: This refers to the degree of price fluctuation in the underlying asset of an options contract. Volatility is a key factor in determining the price of an options contract because it measures how much the price of the security is expected to move up or down within a given time frame.
• Time Decay: A term that refers to the gradual decrease in an option’s value as it gets closer to its expiration date. Regardless of the underlying asset’s price movement, the option loses value simply due to the passage of time. Time decay is also known as “theta decay.”

How Options Complement Ethical Investment Strategies

Options are one of the best investment options for traders who are interested in ethical investing. They offer hedging opportunities, the ability for investors to generate additional income through premiums, and allow traders to leverage limited capital to control a larger investment.

Hedging Against Ethical Investments

“Hedging against ethical investments” refers to taking a complementary investment position that offsets the potential losses or risks associated with ethical investments. Investors can maintain their ethical principles while also protecting their portfolios from significant losses that could occur, but it might involve diversifying their portfolio with investments that might not completely agree with at times.

There are a few reasons that investors would hedge against ethical investments, including the following:

• Market Fluctuations: Hedging helps to insulate investors from potential market downturns due to ethical investments’ industry restrictions and their tendency to underperform the broader market.
• Keeping With Your Principles: To the best of their ability, investors must choose options that align with their principles and beliefs but do so in a way that helps them achieve their ideal risk mitigation. This doesn’t always happen perfectly, however, because hedging involves taking an opposite position with a related asset, industry, or sector, so some hedging against ethical investments includes the use of non-ethical investments.
• Diversifying Your Portfolio: This brings us to making as diverse a portfolio as possible, which might have to involve non-ethical investments. Some investors might want to strike a balance between keeping with their principles and still being profitable, so it’s important to pick and choose which non-ethical investments would serve their portfolio best. Involving these kinds of investments can lead to better diversification.

For a better example of what we’re referring to, a common hedging strategy for dealing with the downside risk in ESG ETFs and stocks is the use of put options. Investors need only pay the premium and the put option functions like an insurance policy. It will protect the investor if the asset’s price declines.

Protective Put Basics

– Investors purchase a put option for a stock they already own or one that they’re getting ready to buy. It gives the investor the right to sell the stock at the strike price by the expiration date.
– The cost of the protective put is the premium paid. If the investors held the stock, the return would only be slightly higher than the return gained from using the protective put strategy.
– Protective puts limit potential losses—investors profit if the stock increases in value.
– Protective puts are a great alternative to stop-loss orders. Investors don’t have to worry about an unwanted order being triggered at an inopportune time using the protective put.
– Protective puts are there to guard against future risk but there’s a chance you might not even use it.

Mitigation Strategies for Ethical Investments

One of the best ways to mitigate risk with ethical investments is simply selecting companies that have taken proactive steps to mitigate the risk associated with their respective industries. Let’s look at a few examples of mitigating risks for renewable energy or clean technology investments:

Financial Risk Mitigation Steps

– Blended Finance: Invest in companies that have a combination of public and private funds—this greatly reduces your investment risk.
– Insurance: Invest in companies that have taken the proactive steps of buying insurance policies to cover potential losses relating to equipment damage, natural disasters, or delays with construction.
– Debt Financing: To better manage cash flow, some of these companies in the ethical investment sector will secure loans from reputable industry leaders, loans that have favorable terms. These are the ideal companies to invest with, those that have proper debt financing.

Technical Risk Mitigation Steps

– Select the Technologies: It’s best to choose to invest in the technologies that have the best-established track records. Choose those that are the most proven and reliable.
– Select Companies That Are Prepared: Invest in compares that have implemented thorough maintenance schedules to prevent equipment failures.
– Location, Location, Location: Ethical investors will benefit from choosing companies that have optimal locations for wind or solar energy generation.
– Companies with Performance Guarantees: The best companies to invest in are those who have warranties that ensure that their equipment operates at the best possible efficiency levels.

Market and Policy Risk Mitigation Steps

– Feed-In Tariffs: Invest in companies that take advantage of feed-in tariffs, government policies that guarantee price premiums for incentivized investment, and renewable energy.
– Policy Analysis: Ethical investment companies should have a stable regulatory framework. Investing in such companies with transparent policies can greatly reduce uncertainty for investors.
– PPAs: Ethical investors can greatly reduce their price volatility risk by choosing companies that have entered into long-term contracts for a fixed price for electricity generated with utility companies and other corporations.

Operation Risk Mitigation Steps

– Data Analysis and Monitoring: It’s best for ethical investors to buy a stake in companies that regularly use data analytic tools to track their performance and find areas where they need to improve.
– Risk Assessment: Choose investments with companies that regularly conduct risk assessments to pinpoint potential risks and form contingency plans.
– Project Management: Choose companies for your ethical investments that have top-notch project management practices. These companies are more likely to adhere to their budgets and complete projects promptly, which greatly benefits investors and stakeholders.

Generating Additional Income

How can ethical investments help investors generate some additional income each month?

One of the main strategies for accomplishing this is selling covered calls on ethical stocks to earn premiums while holding long-term positions. Covered calls are designed to give the buyer the right to buy the shares on an ethical investment at a set price within a certain timeframe. Investors still maintain ownership of the underlying shares unless the option is exercised.

Covered calls allow ethical investors to earn a steady stream of income through collecting the premium. This happens even if the stock price doesn’t significantly increase. So long as the stock price stays below the strike price at the option’s expiration, the investor can collect the premium they received when selling the option. Covered calls also carry the blessing of effectively managing risk for the ethical investor. They cap their potential upside gains on the stock but also mitigate downside risk if the stock price falls.

Benefits of Trading Options within Ethical Goals

What are some benefits of aligning options income with ethical goals?

• Sustainable Returns: Investors can enjoy long-term sustainable returns. Many socially responsible investors have experienced good results, but it’s mostly centered on long-term investing. Ethical investments tend not to perform as well with short-term market movements and price fluctuations.
• Trade Within Your Value System: Get returns on your investments and do so by knowing you’re supporting companies that you feel are trying to make the world a better place.
• Reduce Risk in your Portfolio: Investment funds and companies are beginning to take a more ethical approach to investing to ensure their long-term survival. Trading options within your ethical goals increases your likelihood of choosing companies that have the longevity to produce long-term returns for your investments.

Leveraging Limited Capital

Not all traders who are interested in ethical investing have the capital they need to simply buy the underlying stock. This is where buying call options can become advantageous to these investors as it allows them to leverage limited capital. Using call options can help them gain exposure to ethical companies without requiring full capital investment.

Let’s take a look at an example of buying call options with a clean energy or biotech sector stock. Now, some investors could afford to purchase the underlying stock, but they stand to lose the entire investment if the market goes against them. However, investors who buy call options with ethical companies can enjoy the same upside if the stock goes up (minus the premium) and they don’t lose anything if the stock goes down besides the premium! It’s much better to use call options on these investments instead of buying the underlying stock because you can limit your downside risk and still make money using the limited capital you have available!

Ethical Considerations in Options Trading

Ethical options trading involves choosing ethical underlying assets and avoiding speculative practices. This next section of the guide will cover all these ethical considerations and what investors can do to choose the best positions for their portfolios. Learn about the criteria and metrics you can use to pinpoint investments that go hand-in-hand with your values, beliefs, and worldview.

Choosing Ethical Underlying Assets

To ensure the underlying stocks or indices meet ethical investment criteria, consider these key points to find investment opportunities you can get behind:

• What Are Your Values?: The first step is clearly defining your values. This will inform which kind of companies you’ll be investing in in the future. Ethical issues can include animal/human rights, the environment, or pro-life/pro-choice.
• Positive and Negative Screening: The next step is to identify the companies that stand for your ethics and those that don’t. Keep in mind that excluding a large swath of companies can severely affect your diversification and hedging opportunities. If you’re too picky with who you choose and who you exclude, you won’t experience much growth.
• ESG Factors: A helpful factor in figuring out where some companies stand regarding the issues you’re passionate about are ESG factors (environmental impact, social practices, and corporate governance). Use this criteria to find out how closely each company aligns with your values and beliefs.
• Thematic or Impact Investing: Use these tools as well to inform your ethical investment strategy. Thematic investing focuses on key sectors like affordable housing, sustainable agriculture, and renewable energy, while impact investing focuses on investments that create measurable positive social or environmental change.

A few great examples of ethical underlying assets are sustainable agricultural businesses, renewable energy companies, green technology firms, ethical investment funds, and socially responsible corporations, just to name a few. If you’re uncertain how you can get started, we’d recommend looking into some of these sectors and industries. Learn about the companies to see if their values align with yours.

Avoiding Speculative Practices

Speculative investing is a high-risk, high-reward trading technique that involves buying or trading assets to realize a considerable profit. The entire goal of speculators in the options market is to exploit inefficiencies in the market or emerging trends to make quick returns on their investments. While speculation can be profitable, it’s also highly risky due to the uncertainty involved.

Responsible trading is aligned with ethical principles, so it’s best for ethical investors to avoid speculative practices where they’re attempting to exploit emerging trends of inefficiencies. Speculative trading is opportunistic and this doesn’t necessarily align with the principles found in ethical investments and responsible trading.

Avoid strategies that conflict with long-term values, such as naked options or excessive risk-taking. Specifically, naked options refer to an options contract where the seller doesn’t own enough of the underlying asset to fulfill the obligations of the contract. This is a risky trade because the investors could experience large losses if the underlying asset changes drastically before the expiration date. The primary advantage of selling naked options is being able to generate income through the premiums received from the option’s buyers. However, it’s too risky a proposition to be considered as a strategy for ethical investors.

Example—Building an Options-Backed Ethical Portfolio

If you’re wondering how to successfully build an options-backed portfolio of ethical investments that match your values and beliefs, you can get some ideas in this next section where we outline the portfolio’s composition and the practical application of effectively incorporating specific options contracts that align with your trading mission.

Portfolio Composition

What is your portfolio going to look like? It’s mostly going to be centered on asset classes like stocks, ETFs, and bonds. View the rough steps below to find out how you can begin forming the basis of your ethical investment portfolio.

1. Define your investment objectives. Then select ethical stocks or ETFs by using positive/negative screening, ESG standards, and thematic or impact investing practices.
2. Define your target allocation. This refers to the composition of your portfolio across multiple asset classes like stocks, bonds, ETFs, futures, etc.
3. Research your options. Make sure your investments align with your values concerning social issues, the environment, or governance factors.
4. Allocate options strategies for hedging, income, and leverage.

Practical Application

Let’s talk about ethical investing and practical application—the following is a walkthrough of an example using a renewable energy ETF. How would it look if you wanted to include this investment as a position in your portfolio? We’ll give you some step-by-step instructions for executing this hypothetical trade.

1. A renewable energy ETF encompasses many sub-sectors, so go through your options to find out which one works best for your trading goals. Choose from energy storage, wind, solar, or geothermal sectors, and then select if you want your portfolio investments to have a global focus or be concentrated in a single geographic area or region.
2. Create an index for the companies you’ll choose from to form your ETF investment. This includes creating criteria where factors like renewable energy sources or market capitalization are considered.
3. Choose an index provider to maintain your index to keep track of the ETFs in your portfolio.
4. Get your ETF officially established by contacting the Securities and Exchange Commission for the necessary paperwork. This includes items like registration documents.
5. Another step would be presenting your ETF to investors by highlighting the benefits and investment thesis of each position. These options would include all relevant information such as strike price, expiration date, etc.

Benefits and Risks of Using Options for Ethical Investing

Ethical investing through the use of options contracts might not be the best investment move for everyone. To get a good idea of what you could be getting into with ethical trading, we’ve prepared the top pros and cons that come with this endeavor. We’d say there are about an equal number of downsides and upsides to ethical investing. It has some severe limitations but it can be highly rewarding for investors who want to trade options with companies they see eye to eye with.

Benefits

• Enhanced Returns Through Income Generation: Investors can still achieve strong financial returns through ethical investing. It’s done through consistent income streams like interest from bonds or dividends from stocks. Investors can also put money toward sustainable real estate properties that generate rental income.
• Protection Against Market Volatility: A focus on companies with strong long-term sustainability practices can lead to great stability when it comes to fluctuations in the economy. These kinds of companies are likely to be less susceptible to market downturns that come out of nowhere or negative news that’s tied in with unsustainable practices.
• Capital-Efficient Exposure to Ethical Opportunities: Through the use of options contracts, investors can get exposure to the companies and businesses that align with their values and principles, but they put themselves in a position where they aren’t overexposed to risk. Buying the underlying asset leaves investors vulnerable to losing their entire investment, but options contracts limit downside risk and let investors use a minimal amount of capital to control a larger position.

Risks

• Complexity of Options: Trading options can be confusing if you aren’t familiar with the terminology, how it works, and keeping all the right strategies straight to eventually realize a profit. For some traders, options present a steep learning curve. It’s not impossible to learn but it can take a lot of mental stamina and time to do correctly.
• Potential for Losses: If options contracts are misused or markets move unexpectedly, investors stand to lose capital investments. This is the case with any kind of investing, but it’s worth noting. Traders can become overleveraged in their positions or engage in speculation which involves a lot of risk. In both cases, investors stand to possibly lose a lot of money.
• Ethical Alignment Challenges: Ethical trading can be difficult when it comes to the derivatives market where investors buy and sell financial contracts based on the value of other assets. This includes instruments like interest rates, currencies, bonds, stocks, or commodities. There are many cases where these investments would be at odds with some ethical traders.

Getting Started with Options in Ethical Investing

If ethical trading and investment sounds like an appealing approach to trading, then you should get started as soon as you can. We’d like to quickly point out some of the best tools and resources out there for ethical investing and the key steps that newer traders should take to prepare themselves for the demands of this industry. A lot of these steps are similar to those that any other trader would take, so if it turns out that ethical investment isn’t the right approach for you, you can still slip into other forms of investment quite easily.

Tools and Resources

The greatest tool that any ethical investor needs is an excellent trading platform that offers ESG-focused options trading. You’ll find out quickly that many of the top trading platforms that cater to regular investors can also be used by ethical investors as they carry the tools that get traders plugged into ESG-focused options contracts:

• Charles Schwab
• Interactive Brokers
• E*TRADE
• Fidelity Investments
• Ellevest
• Ally Invest
• Betterment
• eToro
• Webull
• Merrill Edge
• Wealthfront
• Zacks Trade

Key Steps to Begin

We’ve already covered the primary steps to getting started with ethical trading, but we’ll include them again as a little refresher:

• Define ethical investment goals. Find out which sectors are most appealing to you from an investment standpoint, and use ESG criteria to figure out how closely certain companies or businesses align with your values and beliefs.
• Identify suitable ethical stocks or funds. Add these positions to your portfolio once you’ve figured out which companies are the best fit for you to invest in.
• Learn basic options strategies. Trading options on ethical investments is so much better than buying the underlying stock because it minimizes potential losses and lets you control a larger position with a smaller amount of capital.
• Start with small trades and gradually scale. Trading apps usually have paper trading simulators or trading demos where you can test strategies to prove their effectiveness.

Consider Trading Options for Ethical Investments

Options trading works well with ethical investing because it allows traders to manage a large position with little capital invested while also working as a terrific hedge against potential losses. There’s most certainly some decent synergy between options trading and ethical investing, which makes them an appealing trading instrument for investors who want to partner with companies and businesses that share their values, beliefs, or worldviews. You can run up against some challenges with diversification and hedging, but options are largely well-suited for ethical investors.

If you’re new to options trading or ethical investing and you’re interested in learning more about how these investments could benefit you, we encourage you to explore options responsibly and align strategies with your ethical values. Use the resources on OptionsTrading.org to deepen your knowledge and start integrating options into your ethical investment approach.