ERICOPOLY

Suppose you don't want to use leverage, then you need to have enough cash to take delivery if the shares get assigned to you. Okay, you write the $70 strike put for $22. When that settles in a few days you'll have $22 per share in the account. So if you write 1 contract, that will be $2,200. Because somebody is paying you $22 per share, you are really only risking $48 per share of your own money. So your maximum return on equity is 45.83% if the shares run "all the way" to $70. And yet you have a natural downside hedge where if it pulls back to $48 you've lost nothing. Let's say they pull back to $35, which was the March the low - that would bring you a 27% loss.

You meant to write 0+%. You only begin to lose money as it drops below $48, 100% loss doesn't come until stock is at $0.

Another question: How can it be that you can write the 2011 $45 strike put for $8.30 and then buy the $70 strike call for $9.90????? That gives you basically all of the upside potential while taking only downside risk under $45. Once again, securities lending distortion?

I'm trying to figure this out -- these prices look very strange. Scenario #1 -- buy SHLD stock at $67 1) Shares remain at $67 you make nothing 2) Shares go to $100, you gain 49% 3) Shares go to $150, you gain 124% 4) Shares drop to $48, you lose 28.4% Scenario #2 -- write $70 strike 2011 put for $22 and purchase 2011 $100 strike call for $2 1) Shares remain at $67 you make 34% 2) Shares go to $100, you gain 40% 3) Shares go to $150, you gain 140% 4) Shares drop to $48, you lose NOTHING Question A: Why on earth are people buying the shares when the options route provides more downside and more upside? Question B: Is this distortion caused by securities lending income that accrues to the buyer of the shares? And is that why the puts are expensive while the calls are actually rather cheap? Question C: If you are a shareholder and not lending your shares, why aren't you selling and going the options route? Perhaps the answer is that shareholders don't think it is going above $100, but in that case, isn't it safer from a risk/reward perspective to write the put only (and not buy the call)? That way you'd be making 45.8% once it hits $70, but be safe on the downside all the way to $48. Didn't FFH option market kinda look lopsided like this in 2006 where puts were expensive but calls not? And that was when securities lending was really attractive for that stock.

I think you can measure the hate by looking at volatility pricing. SHLD -- if the stock advances 3% by Jan 2011 you make 46% return writing the $70 strike put. That seems a little excessive for basically treading water. Only useful if you are comfortable with SHLD.

Everytime I catch the fearful/cautious side of myself asking that question, and sometimes I worry about it for days at a time, the calmer side of me settles the dispute with "rising population vs declining population". We'll grow ourselves out of the current housing inventory overhang, and then construction ramps up and house prices will be held up by the cost of building new ones. And if the dollar is weaker the cost of building new ones will rise. It's what I tell myself. We'll see what actually happens. All of us will die. That I can promise.

It is in Chapter 15. I have the Kindle edition and they have "location" references, not page numbers. It's at Kindle location 2085-87, but a lot of good that will do you :-)

Personally I like the insurance co with TIPS idea quite a bit because the TIPS pose no risk whatsoever from deflation -- it benefits from deflation because you are guaranteed to get back the original principle of the bond at par (so long as that's what you paid for it, you get your money back). Now, if you have out-of-control deflation the value of your guaranteed principle rises in real terms. And then if the CPI rises you earn (pre tax) a leveraged multiple of the CPI. So you benefit from inflation. High inflation -- good. High deflation -- good. Price stability -- very mediocre (unless your insurance company has a terrific combined ratio).

I do like the book. Mostly because I like to read quotes like the ones above and there are things like that stuffed throughout the book. I like books that center around a particular individual's life, because I typically get a little bit of historical background in a fun format. The tidbits I enjoyed the most were the quotes like the ones above, where the experts thought a depression was around the corner. Good grief, I was in 9th grade in January 1988, and I don't remember any depression. Maybe I was a bit upset that Prom night didn't conclude quite the way I'd always dreamed, but that didn't cause the markets to close down.

Are there any insurers buying TIPS? 3:1 leverage insurer, CPI jumps 10%, 30% pre-tax return on CPI adjustment (plus interest income). Presumably combined ratio takes somewhat of a hit from higher nominal claims.

Right, we've been pretty well pounded by experts on what we're going to expect the next decade. I am just finishing The Davis Dynasty by John Rothschild and in it I found something from a Barron's Roundtable in 1988 that I thought could just as well be published today, except by comparison I think today Jim Rogers is relatively bullish. "A bear market has started that will probably last several years," said dour Felix Zulauf. "We have had the first down leg." "The questions to me," chimed in Paul Tudor Jones, "are not so much... will we have a bear market, but will we be able to avert a worldwide depression like we saw in the 1930s?" "Most stock markets around the world," echoed TV commentator and motorcycle buff Jim Rogers, "are going to go up dramatically ... but no longer than six months, at which point we are going to have a real bear market. I am talking about a bear market that is just going to wipe out most people in the financial community, most investors around the world. And in fact there are many markets I would short but which I will not be short, because I think they will probably close them down."

Suppose you started your own "business" where you merely used conforming 30 yr loans at today's low fixed rates and bought 4-plex apartments? If you do this with a certain amount of leverage, you can structure it so that your rental income roughly covers maintenance/repairs/expenses+taxes+interest (cash flow neutral). Initiallly, because you used a lot of leverage your interest payments are the dominant form of your outgoing cash flow. Now, suppose this inflation comes along that pushes rents up at 10% a year. Your interest payments remain flat so you now become cash positive. This business benefits from inflation. Deflation is pretty bad though.

Lets say inflation wipes out debts. Some people are going to get hurt along the way (consumers who don't get raises in step with inflation). But after the dust settles (inflation subsides), there is going to be a lot of room for growth in consumer spending as consumers won't have meaningful mortgages anymore. Is that what happened in the later 80s/90s?

Thanks for posting this. I have been reading The Davis Dynasty recently. That book had a story about Shelby Davis getting a tip from the man himself in 1974. Ben Graham told Shelby to buy GEICO. It was Graham's largest holding, and I think it was a very significant amount of his personal net worth at the time. Shelby Davis did not buy any. Two years later GEICO was a $2 stock and only survived because Buffett revived it with capital. So, the story goes that if you have all your eggs in your basket you should watch it very closely. Apparently, even the directors at GEICO were not aware of the problems. So much for that strategy.

It is not meant to be a measure of general price increases outside of the prices of the specific basket! Alright then, end of story. ShadowStats says nothing about the general trend of inflation, only a specific basket. It is not a means of suggesting that the BLS numbers are wrong, only that they measure different things. And from what I can tell, the BLS numbers more accurately reflect consumer price inflation and that is exactly what whey told John Williams (who makes money selling his numbers, regardless of their usefulness today).

The BLS CPI predicts nothing! it is not a predictive tool for anything other than future Social Security premiums and payments! ... It is a HISTORIC measure of price of a basket of specific consumer goods and services for a specific purpose. It is probably not a good tool to use for any other purpose or comparison! I was looking at it from the point of view of, if we were in 1991, which would be a better predictor of the future cost of living. Other people might call this "backtesting", I called it "predict" and you are probably correct that I wasn't semantically accurate. Regardless, after backtesting it has been a more accurate measure of price increases than pre-Clinton -- unless you have a basket of important prices that suggests otherwise?

Agree with that. It's purpose is to track what it really costs to live as compared to when they paid their premiums. But suppose you paid your premiums in 1991. Where is the 4x inflation? What exactly do you buy outside of eating at restaurants, drinking beer, buying soda, filling your car with gas, buying a car, buying your house. What is up 4x? What???? I tried to include the major purchases like houses and cars, and that only made prices seem low relative to 4x. Fine, let's talk merely of services, not assets. Pizza is not an asset, neither is beer, neither is soda, neither is toilet paper. In 1991 a haircut at Supercuts was $8. Is it $32 today? Not even close, it's about $13-$15, depending on location. The BLS CPI predicts it would cost $14.75, while the pre-Clinton CPI says about $32. There was a popular gameshow with a buzzline "You could be the next contestant on The Price is Right!". Who is winning this game so far? The pre-Clinton CPI or the new CPI?

ShadowStats suggests 4x rise in prices since 1991. (I can't tell the exact number because they only supply a bar chart, not a number). A baseline 4wd Chevrolet Suburban cost about $20k ($18,540 MSRP) in 1991 and I paid $34k for a brand new 2008 Chevrolet Suburban LT2 from a local dealership in 2008. The MSRP was $48k but this was not the baseline model. The LT2 is practically fully loaded. It did not come close to the $80k or $100k that ShadowStats CPI would suggest. The quality today is much higher than in 1991. This is a luxury car now, compared to the trim and features of the 1991 car. The baseline MSRP of the 2009 4wd model is $43,215 (133% price increase but higher quality, more features). BMW: 1991 535i $42,900 MSRP 2009 535i $47,010 MSRP (it is a better car too) I worked at Round Table Pizza in High School. In 1991 it cost about $18-$20 for an extra-large King Arthur Supreme pizza. Today it's $27.50 for the same pizza. Not even double. Same pizza. Beer is not double. Pizza is not double. Cars might have doubled. I paid $380 for a Sage 490LL fly rod in 1994. Today they are about $700 for the similar top line of rods, and they are still manufactured at the same plant right here in Bainbridge Island, WA. The quality is better on the new rods too. Median house prices have certainly not quadrupled since 1991. The median price for a new house in 1991 was $117,900. Today, it is about $200,000. Not even double! http://www.census.gov/const/uspricemon.pdf There are a lot of prices that are nowhere near 4x that ShadowStats suggests. Mostly, I see these 50%-100% price increases. But I can't find anything that's gone up 4x. Not even gasoline! Gas today is roughly twice what it was in 1991 -- maybe up 150% (despite rising global demand, peak oil, and other explanations for a long term trend up even without monetary inflation): http://www.randomuseless.info/gasprice/gasprice.html So what the hell is he measuring? I can't find things that cost 4x as much, so there might be some things that John Williams is counting that are up at least 10x or 20x in order to bring up the average to 4x.

There was a thread about Polish Re getting a negative ratings outlook earlier and it had something to do with the high equities concentration in the portfolio and the risk of potentially being in a compromised position regarding claims due to a global equities crash. So the investment mix scares the ratings agency, which in turn may scare the customers (lower credit rating). My understanding is that Berkshire can invest it's insurance subsidiaries into equities without that kind of a problem due to the wide and diverse number of cash generating operating subsidiaries within Berkshire. I'm suggesting that keeping the operating subs intact within Berkshire allows the insurance subsidiaries to rake in more cash. So it would seem that splitting it apart weakens the value of the insurance subs. And keeping it together allows Berkshire to occasionally add an insurance sub that can make more money as a part of Berkshire than it could standing on it's own (it picks up the stronger credit rating and clients like that).

All their beer is cheap though. I think the price of a six pack Coors is also roughly unchanged after 18 years. Newer "specialty" beers are pretty much the same price too, if not cheaper. That website ShadowStats.scom suggests that a $5 sixpack of Budweiser ought to be about $25 bucks right now. http://www.shadowstats.com/inflation_calculator?amount1=5&y1=1991&m1=8&y2=2009&m2=8&calc=Find+Out There must be something special about the beer market that is holding inflation down. $25! Come on, not even close.

Removing the gold peg only means that it is now mechanically possible for the Swiss Franc to fall in price vs gold. It does not explain why it is happening. Why is it happening to the AUD? Why is it happening to the CDN? Neither of those two countries have recently moved from the gold standard. They are not undergoing monetary inflation on the scale of the US. An explanation for the scale of the price movement in gold vs a basket of important world currencies needs to be more sophisticated than merely "US Fed action". I think the problems with the US management of the dollar and deficits explains why it is depreciating vs a basket of world currencies. That makes perfect sense. But it's a different conversation entirely when discussing why gold is blowing away that same basket of world currencies. You mention that gold is trading at a premium, and that is part of the explanation. The other part of the explanation is probably that (along with many commodities) gold was likely trading at a severe discount earlier in the decade. So rather than "monetary inflation" as the answer, it is more likely that it isn't even the biggest factor behind the gold movement -- a huge part of the swing is likely going from a position of discount to a position of premium. After all, the other world currencies have seen nowhere near the rise that gold has seen. Similarly, Fairfax stock might rise 80% from some low point earlier this year. Somebody could say, "it's because they made a lot of money", which is true, however it's significantly due to the discount vs premium factor.

I went to Walmart yesterday. A six pack of Heineken was $6.99. I don't think it has changed in price since I was graduating high school in 1991. In fact, I think it is cheaper now than it was then. When consumer prices are calculated, where do they go to shop for prices? Do they go to Walmart or do they go to the mall?

I wouldn't credit the goldbugs for recognizing that the dollar ought to slide against relatively stronger currencies. The goldbugs are simply the ones that only see one way to go: gold at any price. They don't focus on what is happening to gold vs Swiss Francs, they are satisfied it seems only that the USD is depreciating and gold is going up. That's why I think they are wackos. If they instead saw merely that gold is but one of many options, they could be deemed to be reasonable people. Ask a goldbug why gold has skyrocketed in USD terms and they say "monetary inflation". Ask them why it has skyrocketed in Swiss Francs and they say " ", they dodge the question actually. Warren Buffett for example has been expecting a USD decline for years, but we get more intelligence from him than simply "buy gold". He sees the problems in the USD, but he is not a goldbug.

As for supply... At $1,004 per ounce, there is only enough gold in the world to support one billion people, each with an individual net worth of $5,000. The total amount of gold is only worth $5 trillion ($5,000 evenly distributed across one billion people). So there are easily one billion people on this planet with that much money. What will the rest of the people do? On a gold standard, how could redemptions be met if everyone demanded payment in gold? That was the problem with the US under Nixon, the gold standard failed because there was not enough gold to meet redemptions. If we put the world on the gold standard, will things be any better?

Cows breed. Yes, the supply of cows is elastic, putting downward pressure on price as the new supply of cows come on line (cow inflation). This is a problem with using most biological commodities as a store of value... supply is not constant. The supply of gold is static, it is practically indestructable (supply can not be decreased and is finite and relatively small.. ) From what I have read (which may be wrong), silver is being consumed and thus has an edge over gold if that is what you find valuable.