"ESG" stands for Environmental, Social and Governance. These factors are used to evaluate companies and countries, based on how they comply with sustainability principles.

Environmental factors include the contribution a company makes to climate change through greenhouse gas emissions, along with waste management and energy efficiency.

Social factors include human rights, labour standards in the supply chain, any exposure to illegal child labour, and more routine issues such as adherence to workplace health and safety rules.

Governance factors refer to a set of rules defining rights, responsibilities and expectations among the various stakeholders in corporations. A well-defined corporate governance system can be used to support a company's long-term strategy.

Proper and transparent corporate governance can help avoid conflicts of interest between the company's stakeholders as well as potential litigation.

The following items detail some of the benefits from sustainable investing:

Financial performance: There is growing evidence that sustainable investing can lead to outperformance, particularly over the longer term, versus investments that do not specifically look at ESG factors. This is most evident when ESG indices are compared with non-ESG benchmark indices.

Improve risk management: Because financial statements do not traditionally capture intangible risk/reward factors, incorporating analyses of non-financial risk/reward considerations can help improve risk management.

Alignment with investing values: The ability to align investment objectives with values is another key feature of sustainable investing. While traditionally seen as important to millennial investors, this ability to create value and values alignment is now gaining traction with Generation X and Baby Boomer investors.

• Requires a smaller initial outlay compared to buying the underlying stock (greater cost efficiency)
• Offers buyers predefined maximum risks and returns
• Enables investors to generate income on existing portfolios

An investor reads about ABC Inc. increasing R&D expenditures to help protect the environment and create a greener future. The company's actions align with the investor's beliefs, and he or she wishes to invest in ABC Inc. using call options.

The investor buys calls as a way to profit from a positive outlook on the underlying stock's price, without the risk and upfront capital outlay of outright stock ownership.

The smaller initial outlay also gives the buyer a chance to achieve larger percentage gains (i.e., greater leverage).

Maximum gain: The profit potential is theoretically unlimited. If the stock price rises as expected, the investor could either sell the option at a profit, or exercise it and purchase stock at the strike price.

Maximum loss: The maximum loss is limited and will be incurred if the investor is still holding the call at expiration and the stock is trading below the strike price. In this case the option will expire worthless, and the investor's loss will be the price paid for the call option.

If an investor is holding a stock that is exposed to ESG risk, put options can be used to help offset that risk. To establish the hedge, one will need to calculate the magnitude of the impact of the ESG risk on the share price.

A put option added to a long stock position insures the stock's value. This strategy is called a "protective put." It establishes a "floor" price under which the value of the investor's stock cannot fall. If the stock price keeps rising, the investor benefits from the upside gains. Yet no matter how low the stock might fall, the investor can exercise the put to liquidate the stock at the strike price. If the stock falls below the strike, as originally feared, the investor has several choices:

• Exercise the put, which triggers the sale of the stock. The strike price sets the minimum exit price. If the long-term outlook has turned bearish, this could be the most prudent move.
• If the worst seems to be over, the investor can hold on to the stock and sell the put. The sale of the put option should recoup some of the original premium paid, and may even result in a profit. If so, it in effect lowers the stock's cost basis.

Maximum loss: The maximum loss is limited. The worst that can happen is for the stock to drop below the strike price. It does not matter how far it goes below; the put caps the loss at the strike price.

Maximum gain: In theory, the potential gains on this strategy are unlimited. The best that can happen to this position is for the stock price to rise to infinity. If the stock price rises sharply, it does not matter that the put expires worthless.

The put option can provide protection against a downturn during the term of the option. The drawback of this strategy is its cost, which raises the stock's cost basis.

This can be achieved by aligning your values with your investment decisions and improving your risk management.

The use of options can provide investors with a customizable and sustainable investment solution that aligns their financial goals with their environmental, social and governance values.

Company-specific ESG factors can be used in option pricing models.

By leveraging the benefits found in options, investors can now easily obtain or modify their exposure to a particular security or ETF that resonates with their ESG values. Or they can even purchase specific stocks or ETF insurance on the ESG factors that the investor believes the particular security is exposed to.

Regardless of whether an investor has a bullish or bearish outlook, there will be an option strategy that will allow them to integrate sustainable metrics into their investment objectives. To see all the options available and listed by the Exchange, click here.

The Montreal Exchange offers a wide range of educational content and trading tools on options. To learn more about options, visit: m-x.ca/education.