Talk Your Book: Investors Love Cash Flow
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Welcome to animal spirits, a shell about markets, life and investing. Join Michael bada and ben carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and ben are solely their own opinion and do not reflect the opinion of red house wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of bridge holds wealth management maintain positions in the securities discussed in this podcast.

Welcome to animal spirits with Michael and band. Today we're talking about the shelter equity income strategy um which is a portfolio of V C A hundred yes, and selling calls against the individual security, unlike some of some of the more recent proper at the index level. It's funny as as this category has exploded to think I said one hundred twenty billion dollars assets. It's interesting that I did an environment where now these are paramenters income oriented strategies right by definition, when your phone calls, you're giving away some website yet a little the downside protection depending on the market environment, but the ideas that this is an income straw, right? And it's it's sort of ironic that this category exploded as fixed income was finally offering hiring yields and we're .

in a bull market.

yeah. I I think I think a lot of the popularity is due to the fact that twenty, twenty two, where such a shit year for both stocks and bonds and a lot of these strategy, depending on the type of portfolio and not only where they delivering income, they were also, again, not everyone, but a lot of them, they were selecting individual, had a more value oriented defensive tilt. So IT was the double, and me in a good way.

And one and two and two. And we know investors chase performance. So I think that that pride was the Spark. And then what kept going .

was people love their income. My theory too is that yield is the easiest sale there is in terms of if you if your strategy is going to be a little complex than the plane, venal strategies and if you're using option that is a little more complex, yield is a wonderful selling point for more investors understand yield yeah of this is the yellow on getting this is the of your targeting. That's why things like private credit is an easy sale. The people .

because what the line the bottle is, this rage targeted sixty nine percent. Uh analyze income and people get IT yeah I understand that they might not understand exactly how the options work in the fade in the age and this and that, but they understand that i'm getting the income.

So the most important point he made so we talk to barry Martin today was a portfolio m manager of the shell equity can find and he said, listen, when we do inevitably under perform in a bull market, we don't have people blowing out anymore because they understand this strategy is simple, understand. And I think that is the big key point, and I think that's interesting for portfolio angers and retAiling.

Investors understand more, but I think I portfolio managers love IT when most of their flow has come from financial advisors as financial advisors understand in the educated clients and credit the financial advisers. All right. So here is our conversation with barry Martin from shelving capital management.

Berry, we have heard a lunch from our listeners from places like to walk street journal in other financial publications of the demand for option income funds. IT seems like in the last two, three years, this is a really a segment of the of the market that is taken off. Why is that? why? Why is that the case that these things are so popular these days?

Been crazy. I mean, couple months of the wall street did not came out an article about IT, and they called IT bom Candy.

which is good.

I was going great. Yeah so it's pretty hilarious. And you mean there are one hundred twenty billion in assets? I think last year, the morning story was the second most inflows of of of any um strategy for category.

But I think a lot has to do demographics, right? So you you have these older bombers that are approaching retirement or in retirement and are looking for income um but also alerted income and so this is know a different return pattern and doesn't necessarily perform like you know your typical bonds or reads or M L P S. Um so it's added to income portfolios and it's just an attractive tractive way to get cash low.

So you guys have been run in the strategy for a long time. Or are you like, hey, what you know get off my lawn or this I rising five. How do you feel about the sudden popularity that you've been running .

for a long time? It's been crazy. No, I it's been a passionate mine for twenty five years. I've been doing IT and you know you had the absence flows of covered option writing um it's been in favor. It's been not a favorite.

But right now, IT is kind of like the glory days, I think, which is great for that. I mean, we've obviously seen a lot inflows, but the but the returns have i've done very well. So so you know i'm excited about IT.

Um also you know smaller player in the in the area but you see uh black rock goon sex um you know everyones obviously J P Morgan is jumping into the pool. So it's it's confirmation of what i've been doing over, over all the year. So it's great for summer. Really excited about .

so what are some of the ways to disagree h yourself from these other strategies?

Yeah um we different a couple of different ways. First of all, we're selling individual calls on an individual names. So I think that's a big differential.

So not doing on the index.

not doing the index, not doing the index. We're doing individual calls on individual names. Um I like that because you be more proactive um and so we're not trading options on the thursday before exploration.

And you know sitting on our hands, we're constantly active with with these option positions. We have over one hundred positions. So the diversity portfolio, but the reality is, I mean, we can sell options that are further out the money than an index call because, you know you get more volatility, individual names.

So we take more off the table if we want to or we can write time and take more of table. Um but if you look at like our upside capture to little bit higher than our competitors, and I think that has lot to do with us writing individual cause. How much .

flexibility do you have in terms of differentiating between what calls you're going to sell on what stock based on market environment, based on what you know, interest rates and option premium, all sort of stuff is IT. How much of that is rules base for us as directionally?

yeah. So it's rules base in the point that are our goals to generate anywhere between six and nine percent and an annualize cash low target. nice.

So what i'm selling the options that, yes. So what i'm selling the options that forty five to sixty to ninety days out, i'm looking foreign and realized target in that range. And so that's a determined of the strike that we're going to sell. I also want some upside on the position. So you were selling typically options with delta between thirty and forty.

What does that mean?

yeah. So delta is a couple different things. How I look at IT like a delta of thirty five means when the option moves a dollar, the option Price will move thirty five cents um but I also look at IT like when i've sell adult thirty five but also means that there is a thirty five percent chance and exploration that IT will be in the money.

Um so we're selling options. I basically have like a sixty to seven percent chance of not being called away. So it's out of the money, something that at the money is usually a delta around fifty.

So that kind of how we look at IT. So we we have a balancing neck that we're trying to do is between upside of the underline equities and um the cash load that were receiving from selling the calls. And are you doing IT?

I see one hundred positions in in the fund and we're talking about the child equity income fun here. Are, are you doing IT every holding in the fund? O R. The specific holdings that make more sense to sell the options on?

Yes, so have options on each one of the holdings. So every position has has a called in against IT. We're not necessarily trying to time the market. You'll see some more take options off, put options on.

Um we're consistently selling cover calls and how we still cover calls a little different others as well is that if I have ten thousand shares an apple, that means I can sell one hundred calls. The reality is that I don't need to sell all hundred calls to hit our target of sixty nine percent um by just selling about thirty percent of the position or thirty percent of the calls. Um I can hit that target.

So if i'm selling thirty calls and um the market appreciates, I could actually rolling those options. So that means that i'm buying the options back and selling more calls on the way up. So it's it's a process of of basically letting the stock appreciate while also money off the table by selling the course.

I don't want to take for granted the fact that people might not might not know what happens when the stack is cool the way so you walk to how that works .

yeah when you sell an option, you're selling someone the right but not the obligation to purchase the stock of you at a pretty terrible Price.

That was a really good cfa answer right there. So that's the definition I learnt on the cfa.

Yeah I think before .

the yeah so for example, if we can use a you use applies as an example, apples roughly around two hundred and twenty five dollars a share. You can sell someone to december two forties and someone's going to pay you for that right to buy IT off you at december at two thirty, which is third friday of the night. So when I sell the option, IT doesn't necessarily mean it's it's going to get called the way for us either.

So uh, I this option, I can also buy back that option. Um but typically what you do is you wait till the third friday of december. And if the stock is in the money, that means the stocks going to get call away for you when call the way means you have to sell sell the stock or deliver those shares to the person that bought the call from you. And so in most cases, um if the stock is in the money would like and we want to keep the stock, we will likely buy that option back before gets called away for us and sell another option and roll up the position. So we'll see some upside of the underline equities .

by doing that. I'm curious how you look at your like your list of stocks that you want to purchase. Like if you have a stock to gets called away, are you going to be looking to purchase IT back right away? Or do you have another stack waiting in the wings to use IT as like a rebalancing mechanism? How does that process work when you do have to turn al over the fund when these stocks at you up a band?

yes. So um you know when you right cover calls you have a metric returns um meaning that your upsides capped at a certain level and have a lot of downside risk. So we really have to be careful about the stocks that we own.

I grew up playing tennis. I play tennis and in college. And then I I coached my daughter through tennis and now SHE place tennis in the big ten. And tennis a lot like covered option. Um they say you know eighty percent of points are lost, not one.

And basically you need to keep the ball m accord and it's hard to to win a match by heating a lot of winners because you make irs when you trying to tempt the winner. So I can't hit home runs um you know I I can barely hit a double because a metro return. So we're looking at stocks that that have a defensive quality, that are market leaders and stocks that actually generate free cash low.

And and that basically goes back to when you're looking at equity, you have the metro or you're looking at cover, right? And you looking at the same metal returns, your upside cap love downside Grace. So you really have to manage that downside Grace.

So we have a process that basically screening process that looks at underline equities that, that have that this defense equality of generally free casual but also equity that are on a positive trend. I think, you know, it's important to look at that as well because our time actually isn't that, that long. I'm not only the stocks for ten years, I could literally only only stock may be forty five to sixty days, right, and selling cover cost.

So I called away from us. So we have a ranking process that, that we created where we believe we're buying the best stocks in the S M P. Five hundred to sell cover call. So saying that if a stock goes in, the money gets called and we don't want want anymore gets called the way it'll be replaced with whatever replay that stock in that crate in the in the each sector, the S A P.

I think people think about maybe you give up some your upside, you're selling calls and therefore, you're going to have some some question on the downside to me. I think about this strategy more than income oriented strategy as opposed to dance side protection because yeah, if the markets down, twenty two percent are making the stop, you might be down nineteen and I could be down eleven, right? Like how do you talk .

to to investors? You I didn't .

because that because .

if you're thinking about like jeffie, for example, like it's a defensive portfolio, maybe not that went specifically, but some of the underline names, IT was a value oriented portfolio. So IT, wasn't that the option premium save investors on the downside, IT was more of the nature of the underlying holdings. In that photo, barry, in my character.

yes. So like as we mention you know, twenty two mark O S down around ninety percent. We're down about ten and that differential at nine percent was mainly the option premium.

But typically, what I get nervous about in a kind of go to your point is that there there are options nobly, products that do cover calls on the nastec. I'm not a big fan of that because the national if I own the nasdaq, I want the upside like i'm buying the nasdaq for upside. I I don't really want to buy the as deck for income.

And then he goes to your point is like you're in the next stack and you're running cover calls, your cap in the upside, what do you have? You have a lot of downside risk, right? And so so you have to be aware of, of that.

And so I shy away from that. Like I think when you're looking at recall, right, you got, oh, man, I can get twenty percent for selling this call. Well, well, the reason get twenty twenty percent, that's all the fall.

And so you're selling the way the up upwards fall and you you're holding the downwards fall so that this makes me nervous. So so you'll see other covered option writers where they stick to like value security and cell cover calls. I'm a blended portfolio. So we have an amazon and here we have an invidia. We have google, but then we also have your typical eighties and stuff like that and that so I think I blender ded approaches more appropriate because even even in the way we look at is stocks that are generating free cash low ten to perform weather Better in like that downward market.

So so I guess that with the company like A T N T, you could sell call options that are ten fifteen percent out of the money over, you know, whatever, three months, six months period, and feel relatively comfortable as possible to in video, you give that ten percent I get called the way you know in in four hours. Like are you more like this something for on video that's further out of the money?

How does that work? Yeah so we look at the vote. Wait, we actually when we look at cover call writing, we actually have um an expectations of yellow target that actually includes that the underline dividend as well.

So eighteen t pace and night divided, we don't need to generate that that much more from selling cover calls, the volatilities on the low in. So it's is kind of like it's just adding a little to that, that dividends being paid in video. On the other hand, you're right, you know, to get six to nine percent of the video, i'm only selling options.

I maybe ten percent of the of the portfolio and that hits that, that hits that target. But you could you know sell a lot more, take more on the table. IT IT just depends on what your views on and video are in the market.

So votile, ity does blow out and you're in a bear market of recent scenario. You're not ying. You're still sticking in your bands. You're not trying to get greedy. So that just means that you it's easier for you to hit those income targets with, I guess, close your options or whatever.

however works. yeah. So if if you were, you know we go back to twenty with coveted markets down thirty percent, volatility blows out the water, your expands and sense I am selling individual calls and individuals names. Uh, at that time i'm able to sell options that you know twenty five, thirty, thirty five percent out of the money and still hit that target to sixty nine percent. And so that's why I really like writing, uh, individual names instead.

The index, like if you look at the byre index, which is our benchmark, they're selling calls at that lower level and if they basically get what what we call website, so market moves down dramatically and I can't go back up because you've kept the portfolio at a lower level. Um so that's why I like writing cover calls, an individual names because I cause there's more volatility, individual names and I can really sell the money. Win volatility expands to hit .

those targets because options the the pricing mechanism changes so much. Are you believe that you can it's really hard to do this like quantitate timely algorithm ally.

Then now um you know you can still you can still do IT that way. I mean, we're selling options to a yellow target, golden sex, a White paper a while back looking at that um IT from a risk, just a return. It's it's appropriate to do IT people have other ways to to sell cover calls and and sell options and buy options. But I mean I I think there's there's definitely uh many different ways to to skin this cat.

I so very people, people love income and there's all sorts of behavior reasons why generating income, vie dividends or options is much more preferable to just doing themselves by pressing a few buttons and settle down their principle. I and fully i'm bored of that. I understand where where it's coming from. So how do investors that you talk to think about the actual portfolio like do they do they care about the total reTurners really just I need my six to nine percent income yeah I mean.

it's it's actually becoming more and vogue, I think because IT performs differently, uh, the equities and performs even though equity exposure obviously performs differently from fixed incomes. So we're seeing a most of clients ts are advisers, and we're seeing advisors add this to their portfolio when they had know your sixty forty portfolio and yeah the death of the sixty forty portfolio I wanna call IT.

Ah they're taking ten percent of equity exposure to be ten percent of fixing exposure and adding this to the portfolio. Typically our our standard deviations around twenty five to thirty percent less than the S P um the last three years because we had that downed are we've had similar market returns with lower inter deviation. So from a modern portfolio theory, IT actually performs really well.

Um I use IT you know if if for use an analogy it's you're flying across country and the the guy says the pilot says, hey, we have a storm here and we're going to IT takes twenty five minutes to go around the storm but we will get there in the smoothly right? That's kind of how I quit this portfolio. But IT goes back to your original statement. I would say eighty percent of arc clients uses as a cash low alternative because IT doesn't form like, you know, the bonds reads mlp s. So adding IT to that as well, diversify their .

income portfolio. You mention the byline index. Do they hold you to do? They look at that. They are to compare you to a sixty four. Like what is the the bodies for us advisors that that or or is IT again the income targets the thing they care about?

Yeah no, I think they they definitely verse to the virt index. That's pretty fair. I mean, that's the S M P. Five hundred with index calls in. So it's an appropriate benched part.

But it's hard to say, you know we when we talk to advisers, we go, hey, this doesn't perform like the S M P, right? You know if the market goes up, you know twenty percent will likely know our beers at seventy five, so will likely you be around fifteen. That just kind of help works. But if the markets down like IT wasn't twenty twenty two twenty percent um we will get around produce the ten percent.

So we it's about education um and then then telling their clients you know how this performs and how I should obviously if going a uh sideways choppy market, this to do really well um because those calls are not being called away, right? So you're selling those calls and you're just taking that premium and put in your pocket. So markets like that and and it's just we under perform in the classically upmarket, but IT, IT seems like, you know, we've had this before and we does not seen alfas late. So this year, we under performing because the markets are over well over twenty percent right now, but we're right there around twenty percent. But you know we're not seeing the athletes, but I think that has left you with education and and how the advisers know this is how IT works in certain markets.

So you've been one of the tragedy for a long time. I'm curious and what environment do advisers and their clients get upset? Because to your point, it's a ball market.

Everybody knows that this is a trade that is not going to keep up in a ball market, especially one that that the sort of environment that we're in. So I I would assume that they're understandable in this in this happy market. But what is the market that says where they say to o hey, this isn't doing what I think it's supposed to be doing yeah.

So I think um was a two thousand and seventeen on the vx was like at nine that was tough. That have been impossible, right? Yeah yeah. So right now um with the fixes in the teams, that's that's kind of goldy lock scenario for us.

We're able to get some appreciation and online at ties will hinting our cattle target when the vick is at single digits, like I was during the zero trade environment in the markets, kind of shocking up IT was hard to do. Our strategy, granted, we have underline equities that were going up. We I was a drastic another forming, but I was I was to a point where I had a right title, I had a right closer, the money, those type of thing.

So the upside was limited. Uh, again, we have that bounced y nap because I I like total return. Port folio manager is very important and so I that bouncing act for getting some upside as much as possible while still hit the c target. Um but so markets like that now I think that was a tourist.

That education piece is interesting to me because like on I have talk other managers that manage alternative strategies. And a lot of times, the strategy can be great in terms of the numbers of the shark share, how everyone look at IT. But if it's really difficult to explain to advisors or for advisers to explain their clients, they're going to jump ship.

Do you think that is a symptom of your strategy being relatively easy to explain in set expections? Or do you think that the education piece has gotten way Better over time and people are just advisers are Better at that, like two year point about people blowing out during a bad year? Um that's the biggest nightmare fraud of profilo managers, right? Like, listen, we're doing what we said we were going to do and you're puni shing us for IT but now that seems like IT that doesn't happen is .

about anymore yeah and any goes to the point like i've been do this for so long and I think that's that's one of the the big keys. but. And saying that we've had a lot of education just from like you know A T military job for deli world where they're doing advertising left and right on options.

Obviously, with the mean craze options you have of liquidity going through the roof, cost of options have dropped ramages ally. So I think the public has gotten used to or more secure with the the use of options. Um obviously, we're doing cover calls, which is a very conservative approach.

Two um options. Um so I think that's beneficial. And and and I just become more popular and just people more comfortable with IT. So I think that's that's been one of the main reasons why we're up to, I don't know, one hundred hundred twenty billion in this in this category for morning ter.

Yeah you mentioned earlier that you're portfolio. Can I frequent turn over um what is the what does the stock solution locally?

Yeah so the stock solution is what we're doing is, is again, we have based a metro returns. So my upsides capped at the downside risk. So we're well diversified portfolio gest holders in video with around three percent, and it's similar waited to the S M.

P. And so we're not making any individual name bets or our sector bets because our upsides kept right. So if if IT goes to to like if i'm over way to financial and my financials do really well, they will do as well because i'm going to cover calls, but they don't do well.

I love out under performance in that sector because, uh, i'm overweight that. So we're pretty really careful about that. So again, like we are looking at stocks, we look at the defense of quality, the market leaders and they and they generate you know free cash lab. And and so it's it's a well diverse by portfolio. It's it's it's sector neutral and where we really at value, I believe IT is is selling the cover calls and and really generate that those additional catcher returns um over the over the the the the period that we sell the calls.

Do you have to have any cell discipline then or is getting called away at your sell discipline?

disciple? Is when the stock actually drops out of our um at our court, we have a cortile process where we have top quartile, second four forth. When they drop out the top cortile and is getting called away, they know then we will replace that with the stock that, that went into the top corner. So but you also so .

when even if he doesn't get called away, if the stock on our performance or whatever doesn't to meet your criteria more.

uh, yes, we definitely IT I me typically um we have that flexibility with the options where we can sell options that are in the money that let's say we we're moving out of a position. So we'll start selling options that are tighter or in the money I let get called away. But if something dramatic happens to the stock will straight sell IT exactly .

the way that investors access to your strategy right now to a mutual fund?

yes. So we have a mutual fund syb S E Q T I X. It's pretty much available everywhere. Um I would assume um obviously, you can contact your advisor and um they can look at up as well. And then we have separate managed accounts that do a portfolio that similar to this, it's a mire portfolio of the options, but it's very similar.

What about the etf that that's where a lot of the food into the stretch you have gone as IT doesn't not lond itself to what you do because you're too active. And the question.

how does that work? No, I mean, I I think down the road that something we might be be be involved in, but you know one of the the tractors of the mutual fund versus the etf is mutually funds typically have large and bet gains in the portfolio. So people are so nervous about that, we typically don't have that.

And so most of our gains are paid out on a quarterly basis. Um and the reason for that is that if we have dramatic appreciation of the stock and IT will get called away. So so we don't have these you know stocks that we've won't forever in the portfolio that have large, large gains typically.

So you won't see that in our portfolio. I think this works really well in a mutual fund. IT also also works well in an etf.

Do investors in this kind of strategy you care at all about interest rates? If the ten year went to five percent or six percent, do people lose interest in a cover call strategy here? Are the the rates so high that IT IT doesn't .

really matter if you're looking at option writing in a vacuum and you go back to days of study, the black shawls model in school interest strates is a big factor of of option pricing, but the biggest factor is voluntier ly. But when interest rates rise, you actually receive more for calls inputs. So in a rising industrial environments, actually pretty beneath, I iie for the option pricing.

If you're looking at in a vacuum, if you're looking at under online equities, you know of these interest rates have different, different effect on the online equities. But but but in general, rising interest environment, then you look at historical performance covered option writing has done very well. So it's been great for that. So but we will see like in in a dropping market if you're looking at option pricing in a in a vacuum um when the straits go down, uh, when volatility goes down, then you receive less for for selling the calls .

and puts there for advice and a client. I want to learn more about how they find your charge.

You where do we send them? I can the shopping cap dot com show capital is is you're based in denver, co. Rado is roughly about six billion of management. You know we're not too big but were not too small. So if you call us, if you get a light person on the line and they can you can talk to me if you need to need you have any questions .

going forward.

Thank you. Appreciate guys.

Okay, thank you again. The berry, greg shelton, cap 点 com to learn more email， less animal spirits, but the compound .

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