Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s days. And fortunately, this week, Stu is not on the Stubway. We missed that one last week. That was an obvious one, Stubway.

Yeah, that was easy.

We have a lot of fun with Stu's name here on the podcast, for new listeners. And we have new listeners all the time, so you'll get used to the fun we have with Stu. And part of the fun with Stu is, where is Stu? Because he's been on the podcast taping from all over the world, in different locations, and he was on the subway last week, which was interesting because now I know I can go down the subway and there's good connectivity down there, good enough to do a podcast on the subway.

I know. It’s really something, like we were joining the 21st or maybe the 22nd century.

Yeah, I think every other major subway around the world already had that. It's nice for it to finally arrive in Toronto which, Canadian listeners know, is the center of the universe. So it's amazing that that wasn't in place before. Speaking of technology and being on the forefront of technology, you can also be on the forefront of asset management. And we talked a couple of weeks ago about what you do as a way to enhance the performance of your portfolio on an after-tax basis, through tax-loss selling. It's a way of helping unitholders who own one of the funds that you manage. Are there any other things that you do, any other techniques, approaches, or tools you use, that maybe the average investor isn't doing in their own portfolio, that really enhances the portfolios that you manage in terms of returns, tax efficiency, whatever it might be, for income generation?

Yeah, for sure, Dave, that's a great point. And there is the option market; puts and calls. A put gives me the right to sell a stock, and a call gives me the option to buy the stock. And we can use those in a variety of ways in the portfolio. The price of an option is linked to the volatility, which you've talked about in the past, the VIX. If volatility goes up, the cost of an option often rises. And then the second thing is, interest rates and the duration of that move. What we like to do, because we're always trying to run scenarios on every stock that's in the fund, we like to take the price of an option, which is quite mathematical, and layer in fundamental analysis on top of it. So I could get into a situation where maybe I get to this time of the year and I want to buy a stock and I know it's not going to be for a long time, then I might go look at the call and say, well, how expensive is that call relative to my fundamental view of what might transpire? And if I think that there's a 10 or $12 opportunity in the stock and the call option is only 1 or $2, then I buy the call. I've not disturbed my existing position. I buy the call. I've got this opportunity. Hopefully it unfolds. I then sell the call. I may have paid tax on that small portion, but I haven't disturbed my larger position and the longer-term cost base. So that would be one way.

Stu, just before you go to the next scenario, let's just make sure that we clarify a couple of points along the way so that people who aren't familiar with using options and option strategies understand what you're talking about. So, again, with a call option, it gives you the right to buy at a particular time a particular stock at a specified price.

That's right. And we don't use them to augment leverage. Some people use them for leverage, but we don't. Say you wanted to buy 100,000 shares of something; that's 1000 contracts. So if a stock was $100 and I bought 100,000 shares, that'd be $10 million. If I buy the same 100,000 contracts, I pay just a dollar, but I've got the same exposure set in front of me. On an unlevered basis, those two positions are exactly the same. There are certainly market participants that will try and augment their returns by buying options, but that changes the risk profile.

So let's say I buy a call option on Stu Corp. And Stu Corp is trading at $25. And I have an option to buy one contract call option on Stu Corp for $25 at the middle of December, a couple of weeks from now. The price of Stu Corp stock is $25, so if I wanted to buy 1000 shares of Stu Corp, it would cost me $25,000. But that option, that's priced at $25 a couple of weeks out, it's going to have a very small value. So I can buy a contract, or I guess in this case, ten contracts for a 1000, contracts for almost nothing, and I have the right to buy those shares at $25 two weeks out.

That's right. That option might cost you $0.25. So I've spent $250. And if the stock finishes at 27, if I bought it at 25, sold it at 27, I would make $2 on my 1000 shares. In this instance, I would make $2,000 on my 250. Same level of profit. So we're not using options in that category to augment our returns. Some people will say, I could buy 1000 shares at $25 or I could buy a million call options. That's not what we do. So if the price of the option looks cheap relative to our fundamental opinion, we're more likely to be a buyer of that option rather than the underlying security. And if it looks expensive relative to our fundamental opinion, and maybe the stock has run, then we would write the call option and try and collect additional income. Maybe an example, if Stu Corp was $25 and it was $12 on Labor Day, so it's doubled in three months, and you're going, I think maybe Stu Corp could be $30, but I don't think it's going to be a lot more than that. And you could write that option for 4 of the $5. So you write the option, you collect the $4, you've captured most of what you think is left. Then two things could happen. Stu Corp stays at $25. The $4 is mine. Or even if it goes to $30, I've already collected 4 of the $5. Then I've got the option at that point to either buy the option back. Again, I haven't triggered any taxes or anything like that. Or I could rewrite the option. I could do all sorts of things. So as a fundamental investor, a lot of people associate derivatives as a separate portion of the portfolio. And we've talked about having lots of tools in your toolbox: technical analysis, fundamental analysis, all sorts of things. And the same goes for tools that you might use in the market to best help the portfolio. And on these covered call fronts and use of options, we do it in a variety of the funds. We also have specific ETFs that tactically try and write covered calls to augment income in addition to the dividends that you might receive from those portfolios. The one thing that we do really believe is that it has to be tactical. It can't just be always writing covered calls. So a couple of weeks ago, when the market was down— and we've experienced quite a month—, we were not writing any calls a month ago. Now you're sitting here, and some positions have done extremely well, and you can maybe capture another 5% or 10% move by writing a covered call. That's something that we're giving consideration to.

Yeah, I think one of the things that goes back to the global financial crisis in 2008-2009, and everything that happened around that in the real estate market with derivatives around mortgages and mortgage-backed securities, and people hear the word derivative or option, then they immediately think big risk. What you're talking about, as you say, is that the risk comes from leveraging up. If I'm trying to take a small amount of money and hold a big position in something, that's where I'm adding lots of risk. And you can do that with derivatives. This is a very tactical strategy with a position you already hold to actually manage risk, and again, like you've highlighted, get a couple of other benefits from it for the unitholder of the fund that you're managing.

100%. It's augment returns, manage risk, manage taxes. We don't use them for leverage, for sure. But they have been a highly beneficial tool over time. Options expire the third Friday of every month and it's always nice. At the end of that third Friday, a little bit of money just sweeps into the account for all the stocks that the options have expired, out of the money.

For people listening, again, we try to highlight a couple of things on the podcast. So we're talking to professional money managers generally like Stu. And Stu obviously has spent his whole career managing money, and his whole educational background is around managing money, understanding how options work, how all of these different tools come together to manage risk in a portfolio to enhance returns. So we want to highlight that for those of you who don't manage your money yourself. There are professionals that you can hire through an ETF, or a mutual fund, and they'll do this for you with all of that expertise. Professional money managers. Then we're also highlighting, for some investors who maybe manage money for themselves, different ways that they can approach managing a portfolio the way a portfolio manager does. Stu in terms of options and using options, managing a portfolio, you've got to have a certain level of sophistication and experience and understanding to use options in a way where it manages risk and enhances the portfolio versus how options can create additional risk for you and potentially additional losses. Right?

100%. And we have a team here of people that are managing the option positions on a daily basis. But as to your point, the real key is to understand the risks associated with options. And we're using very plain vanilla, very conventional options, but the key is to think about them as a replacement for an otherwise fully-funded position rather than something where we're trying to accelerate returns. But even at that, we find them to be quite useful components of the toolbox when we sit down to do our otherwise fundamental analysis. And one of the big reasons for that is that option pricing is very mathematical. It's based on volatility; it's not always based on fundamental analysis. So bringing a scenario-based lens to the option market allows us to see which ones do we think might be mispriced relative to our fundamental views and try and add some extra dollars to the portfolio.

You've got a team of derivative experts. It's not like my team that I had out this past weekend, raking leaves; my wife and two daughters. It doesn't take a whole lot of expertise to rake leaves. A little bit of skill to it. I can rake ambidextrously actually, Stu, I don't know if you can do that. A very important skill. It's very effective. And you can go back and forth. It saves a little time, more efficiency, but this is something that is highly specialized. So, if you wanted to get into using options up against your portfolio, I would suggest taking a course available and making sure that you're well grounded, as you suggest in the math, because it's mathematically based. You have to know how the math works, or you can get yourself into a lot of trouble using those kinds of strategies.

That's a 100% true.

Yeah. Or come in with a big paycheck and hire Stu's team away. They're not mercenaries, though. They like what they're doing.

Thankfully, there's more of us who can go take the derivatives course at the Canadian Securities Institute.

When we start talking about these kinds of strategies, I prefer to have those strategies being handled by someone like Stu. When we talk about managing money on your own, you've got to have the time, desire and ability. You may have the desire and ability, but not the time. And particularly when you start to get into options and options strategy, derivative strategies to supplement your portfolio or to help you manage your portfolio, you've got to be watching it. This is not something you just set and forget. And that's where someone like Stu, a professional investor, has a team of people watching this 24 hours a day.

That's right, 24 hours a day. Not 7 days a week, because they don't trade on the weekends, but almost.

Almost, but always monitoring it on Stu’s days. Stu, thanks for another great visit. I love these ones where we tap into that massive brain and learn.

Well, thanks very much, Dave. It's a massive head. I'm not sure about the brain.

Well, there's clearly something filling up that space, so that's a good thing. So, we'll talk to you next week.

Thanks, Dave.