The Mother of All Easy Trades

[onyx1]

The irony of using the Jan 2014 LEAPS for this trade (2015 is not really liquid enough for me atm) is that if WEB were to buy back a large amount of shares this year the BV of BRK goes down.  For example, if he were to spend $22bln to buy 10% of outstanding tomorrow at 120%, BV per share would immediately drop by a little more than 2%.  From WEBs standpoint, this is no problem because EPS will increase by 8-10% due to the smaller sharecount and he will recover his $3.7bln BV premium "investment" in about 3 years (earning over 20% IRR).  For an levered investor in 2014 LEAPs though, the 2% hit to BV is immediate and all else equal a negative since they won't be around long enough to receive the payback from EPS accretion.  Cruel world!  ::)

 

Good point.  Practically, large repurchases should be rare.  BRK's share turnover is very low.  The big recent buyback was about half a percent of all shares outstanding.  Typically other purchases have been more like rounding errors in calculation of BV/SH.  :)

You're probably right that risk is academic, and now that I own LEAPS I would have no problem if the market kept him from having an opportunity to buy any shares at all.

[twacowfca]

I think it might be a decent idea to constantly sell puts at a strike price of 90 or thereabouts. Basically at the money or even a little higher.

You usually want to buy options when volatility is low and to sell options when volatility is high.  That would be the "value" approach to options... buy cheap and sell assets when they get more expensive.

 

2- Remember, you can generally turn call options into puts or vice versa due to put/call parity.

 

A call - a put + risk-free investments = common stock

 

(*There are certain scenarios where put/call parity for stocks can break down, but usually that doesn't happen.)

 

Due to put/call parity holding true most of the time, it doesn't matter too much whether you buy calls or you buy puts.  You can turn calls into puts and puts into call.

 

3- So really, you can break the pricing of options down into implied volatility according to the Black-Scholes model.  There is some value of implied volatility which is the "right"/appropriate value for an option.  When the options trade at less than that value, it is cheap.  When options trade at a higher implied volatility than the "right" value, it is expensive. 

 

The Black-Scholes model has well-known flaws.  Many experienced traders will fudge the implied volatility aspect of the BS model to take those flaws into account.  (So then it starts getting advanced... there is the volatility smile, skew, etc.)

 

 

Realize that the idea of put/call parity is more robust for European options than American.  Thus one can use put/call parity not exactly to create a synthetic long, but more exactingly to create a synthetic future contract with a term equal to the same  terms of the put and the call.

 

I think buying an American call is a better deal because of the optionality during the term, not just at expiration.  According to Warren's statements, the scenario when the quasi put given free to BRK shareholders could become a little iffy would be during a market meltdown.  Then, the American call could be exercised if still above the strike price and the stock sold.  On the other hand,  the call part of the European synthetic long/future could go no bid while the put part of the synthetic long/future could see a big spike in implied vol and be more expensive to buy back.

[twacowfca]

Just an update.  Around EOY 2012 BRK dropped below The new 120% of BV repurchase limit to as low  as $88 and change. This was more than 2% below what we estimated 120% of EOY BV would be.  Therefore we backed up the truck and bought short term $90 strike Jan and Feb calls to goose the returns  beyond the common and LEAPS we already owned. 

 

This, of course, was speculative, but the risk/reward appeared to be very asymmetric in our favor.  The risk/reward was especially favorable because the implied volatility of these calls was modest, unlike the astronomical implied vol on the BAC warrants we bought in the unfortunately micro position sized purchase last year at the same time.  This time the BRK calls were most definitely not a micro position.  :)

 

Happily, these short term calls are now three to five times what we paid for them.  :)

[onyx1]

Just an update.  Around EOY 2012 BRK dropped below The new 120% of BV repurchase limit to as low  as $88 and change. This was more than 2% below what we estimated 120% of EOY BV would be.  Therefore we backed up the truck and bought short term $90 strike Jan and Feb calls to goose the returns  beyond the common and LEAPS we already owned. 

 

This, of course, was speculative, but the risk/reward appeared to be very asymmetric in our favor.  The risk/reward was especially favorable because the implied volatility of these calls was modest, unlike the astronomical implied vol on the BAC warrants we bought in the unfortunately micro position sized purchase last year at the same time.  This time the BRK calls were most definitely not a micro position.  :)

 

Happily, these short term calls are now three to five times what we paid for them.  :)

 

Awesome Twa, great decision!  I'm in the 70 strike Jan 14 LEAPS and happy too.  They are up 16% and plus they have already "paid for" almost half of the initial time value cost through decay.

 

How do you interpret BV as it applies to company repurchases?  Is it BV as published at the end of the most recent reporting period, or is it BV as estimated internally by WEB on the day of a repurchase?

[enoch01]

I've been buying the 2015s, at or slightly out of the money.

 

No reason BV can't grow at 10% per year the next couple of years, I figure.

[twacowfca]

Just an update.  Around EOY 2012 BRK dropped below The new 120% of BV repurchase limit to as low  as $88 and change. This was more than 2% below what we estimated 120% of EOY BV would be.  Therefore we backed up the truck and bought short term $90 strike Jan and Feb calls to goose the returns  beyond the common and LEAPS we already owned. 

 

This, of course, was speculative, but the risk/reward appeared to be very asymmetric in our favor.  The risk/reward was especially favorable because the implied volatility of these calls was modest, unlike the astronomical implied vol on the BAC warrants we bought in the unfortunately micro position sized purchase last year at the same time.  This time the BRK calls were most definitely not a micro position.  :)

 

Happily, these short term calls are now three to five times what we paid for them.  :)

 

Awesome Twa, great decision!  I'm in the 70 strike Jan 14 LEAPS and happy too.  They are up 16% and plus they have already "paid for" almost half of the initial time value cost through decay.

 

How do you interpret BV as it applies to company repurchases?  Is it BV as published at the end of the most recent reporting period, or is it BV as estimated internally by WEB on the day of a repurchase?

 

I'm very glad for you that the trade has worked well.

 

In 2011, immediately after Warren made his first repurchase announcement, it was clear that the limit for repurchase was based on the last reported quarterly BV.  Every time the stock went below that level there was increased volume, and the stock quickly popped back up above that limit.  Then, within a short time, BRK actually reported repurchases when they published the next quarter's results.  During the following several months, BRK's price rarely got down to the repurchase threshold, and never significantly below it as calculated by the latest public quarterly filing.  There were, however one or two times when BRK got below what I estimated the quarterly repurchase value was at the end of the calendar quarter, but before they actually reported.

 

In summary, I have seen no evidence that BRK has made any repurchases based on what an instantaneous estimate would be before that value was officially reported.  However, there did seem to be a possible adjustment in how close to the previous quarter's limit they will go when the market was weak as it was after Christmas until the EOY bounce began.  Formerly, BRK repurchased aggressively when the stock got no more than half a percent below the limit established by the previous quarter's reported results.  However, at the end of December when the market was weak on the verge of the feared fiscal cliff, the buying activity at first kicked in as usual at less than half a percent below the limit, and the stock quickly  popped back up above the limit as it had in the past.  A few days later, as the market was even weaker, the buying activity kicked in strongly after the stock dropped to a range between one and two percent below the previous quarter's limit.

 

BRK may have bought back more shares this time than in the past by making most of their repurchases a little below the limit instead of almost exactly at the limit.  That is assuming that a lot of the buying just below the repurchase limit was by BRK as I suspect.  We should know if this was the case when BRK reports EOY results.  :)

[Kiltacular]

twacowfca,

 

I just wanted to take a moment, as the New Year has dawned, to say a heartfelt and sincere thank you for sharing your thoughts and reasoning about Berkshire as well as other investments. 

 

I definitely don't have the "thank-abilities" as giofranchi -- even though my first language is English and my paternal lineage is Italian -- so I will say, simply, thanks.

 

There are so, so many other people on this board who post truly excellent information that I'm hestitant to name names for fear of leaving others out. 

 

I will say that, unlike virtually any other forum and definitely unlike any other forum I've seen, Parsad has created a situation where engaged and intelligent people contribute excellent information and -- crucially -- the competitive spirit (while always alive and necessary) does not supersede the rational and useful and decent.

 

 

[twacowfca]

Mille grazie! You are very kind in your remarks.

 

The pleasure is mine.  I have thoroughly enjoyed making discoveries and sharing them with others who may appreciate them since I was 18 months old.  The positive feedback from you and others on the board makes it all worthwhile.  :)

[onyx1]

Just an update.  Around EOY 2012 BRK dropped below The new 120% of BV repurchase limit to as low  as $88 and change. This was more than 2% below what we estimated 120% of EOY BV would be.  Therefore we backed up the truck and bought short term $90 strike Jan and Feb calls to goose the returns  beyond the common and LEAPS we already owned. 

 

This, of course, was speculative, but the risk/reward appeared to be very asymmetric in our favor.  The risk/reward was especially favorable because the implied volatility of these calls was modest, unlike the astronomical implied vol on the BAC warrants we bought in the unfortunately micro position sized purchase last year at the same time.  This time the BRK calls were most definitely not a micro position.  :)

 

Happily, these short term calls are now three to five times what we paid for them.  :)

 

Awesome Twa, great decision!  I'm in the 70 strike Jan 14 LEAPS and happy too.  They are up 16% and plus they have already "paid for" almost half of the initial time value cost through decay.

 

How do you interpret BV as it applies to company repurchases?  Is it BV as published at the end of the most recent reporting period, or is it BV as estimated internally by WEB on the day of a repurchase?

 

I'm very glad for you that the trade has worked well.

 

In 2011, immediately after Warren made his first repurchase announcement, it was clear that the limit for repurchase was based on the last reported quarterly BV.  Every time the stock went below that level there was increased volume, and the stock quickly popped back up above that limit.  Then, within a short time, BRK actually reported repurchases when they published the next quarter's results.  During the following several months, BRK's price rarely got down to the repurchase threshold, and never significantly below it as calculated by the latest public quarterly filing.  There were, however one or two times when BRK got below what I estimated the quarterly repurchase value was at the end of the calendar quarter, but before they actually reported.

 

In summary, I have seen no evidence that BRK has made any repurchases based on what an instantaneous estimate would be before that value was officially reported.  However, there did seem to be a possible adjustment in how close to the previous quarter's limit they will go when the market was weak as it was after Christmas until the EOY bounce began.  Formerly, BRK repurchased aggressively when the stock got no more than half a percent below the limit established by the previous quarter's reported results.  However, at the end of December when the market was weak on the verge of the feared fiscal cliff, the buying activity at first kicked in as usual at less than half a percent below the limit, and the stock quickly  popped back up above the limit as it had in the past.  A few days later, as the market was even weaker, the buying activity kicked in strongly after the stock dropped to a range between one and two percent below the previous quarter's limit.

 

BRK may have bought back more shares this time than in the past by making most of their repurchases a little below the limit instead of almost exactly at the limit.  That is assuming that a lot of the buying just below the repurchase limit was by BRK as I suspect.  We should know if this was the case when BRK reports EOY results.  :)

 

Thanks Twa you are very generous to share your observations.  Your short term options have worked out temendously.  With admiration, I looked back on the details at the time of execution.

 

For example on Dec 31:

Underlying BRK B share price ..............  88.25

120% of last reported BV, "floor"..........  89.35

Strike of Feb 15 '13 call option ............  90.00

Price of Feb 15 '13 call option ...............  1.25

 

With the next reported BV date after the option expiration date, the "floor" price was sure to remain under the strike price.  Were you expecting to hold these option to maturity, or were you expecting a higher price on the option from a quick move of the underlying up to the floor of 89.35?

[giofranchi]

I definitely don't have the "thank-abilities" as giofranchi -- even though my first language is English and my paternal lineage is Italian -- so I will say, simply, thanks.

 

Well, I really hate to sound too deferential… But I think there is a reason for it: twacowfca made me know very well LRE, which I do believe will proceed with making a lot of money for my firm in the years ahead. And he did that completely for free! Maybe, I expressed my gratitude too emphatically… But I don’t really care. It seems to me the least thing I could do!  ;)

 

giofranchi

[LC]

I'm just glad there is some sporadic Italian being spoken on this board :)

[Kiltacular]

Well, I really hate to sound too deferential… But I think there is a reason for it: twacowfca made me know very well LRE, which I do believe will proceed with making a lot of money for my firm in the years ahead. And he did that completely for free! Maybe, I expressed my gratitude too emphatically… But I don’t really care. It seems to me the least thing I could do! 

 

giofranchi

 

On the contrary giofranchi!!  You do not sound deferential -- you sound sincere.  And, it was your sincerity, I think, that prompted me to mention you.  So, if anyone was being deferential, it was me being so to you.

 

Frankly, while we're on the topic, your writing has been excellent on investing and your approach and thinking about owner-operators fits with much of how I try to invest.  So, thanks to you as well!

[rjstc]

+1.  For the most part that's the way I've evolved also. Stick with good people, BRK,MRK, etc. Also I've found that ideas by TWACOWFCA, Parsad, Ross812, and a few others on this board have been really good with egos not getting in the way, just good rational, (About Stocks) ideas and discussions. Gio I include you too about great thoughts and discussions.

[twacowfca]

Just an update.  Around EOY 2012 BRK dropped below The new 120% of BV repurchase limit to as low  as $88 and change. This was more than 2% below what we estimated 120% of EOY BV would be.  Therefore we backed up the truck and bought short term $90 strike Jan and Feb calls to goose the returns  beyond the common and LEAPS we already owned. 

 

This, of course, was speculative, but the risk/reward appeared to be very asymmetric in our favor.  The risk/reward was especially favorable because the implied volatility of these calls was modest, unlike the astronomical implied vol on the BAC warrants we bought in the unfortunately micro position sized purchase last year at the same time.  This time the BRK calls were most definitely not a micro position.  :)

 

Happily, these short term calls are now three to five times what we paid for them.  :)

 

Awesome Twa, great decision!  I'm in the 70 strike Jan 14 LEAPS and happy too.  They are up 16% and plus they have already "paid for" almost half of the initial time value cost through decay.

 

How do you interpret BV as it applies to company repurchases?  Is it BV as published at the end of the most recent reporting period, or is it BV as estimated internally by WEB on the day of a repurchase?

 

I'm very glad for you that the trade has worked well.

 

In 2011, immediately after Warren made his first repurchase announcement, it was clear that the limit for repurchase was based on the last reported quarterly BV.  Every time the stock went below that level there was increased volume, and the stock quickly popped back up above that limit.  Then, within a short time, BRK actually reported repurchases when they published the next quarter's results.  During the following several months, BRK's price rarely got down to the repurchase threshold, and never significantly below it as calculated by the latest public quarterly filing.  There were, however one or two times when BRK got below what I estimated the quarterly repurchase value was at the end of the calendar quarter, but before they actually reported.

 

In summary, I have seen no evidence that BRK has made any repurchases based on what an instantaneous estimate would be before that value was officially reported.  However, there did seem to be a possible adjustment in how close to the previous quarter's limit they will go when the market was weak as it was after Christmas until the EOY bounce began.  Formerly, BRK repurchased aggressively when the stock got no more than half a percent below the limit established by the previous quarter's reported results.  However, at the end of December when the market was weak on the verge of the feared fiscal cliff, the buying activity at first kicked in as usual at less than half a percent below the limit, and the stock quickly  popped back up above the limit as it had in the past.  A few days later, as the market was even weaker, the buying activity kicked in strongly after the stock dropped to a range between one and two percent below the previous quarter's limit.

 

BRK may have bought back more shares this time than in the past by making most of their repurchases a little below the limit instead of almost exactly at the limit.  That is assuming that a lot of the buying just below the repurchase limit was by BRK as I suspect.  We should know if this was the case when BRK reports EOY results.  :)

 

Thanks Twa you are very generous to share your observations.  Your short term options have worked out temendously.  With admiration, I looked back on the details at the time of execution.

 

For example on Dec 31:

Underlying BRK B share price ..............  88.25

120% of last reported BV, "floor"..........  89.35

Strike of Feb 15 '13 call option ............  90.00

Price of Feb 15 '13 call option ...............  1.25

 

With the next reported BV date after the option expiration date, the "floor" price was sure to remain under the strike price.  Were you expecting to hold these option to maturity, or were you expecting a higher price on the option from a quick move of the underlying up to the floor of 89.35?

 

We continue to hold most of the options we bought.  We may roll the short dated ones into leaps as they near expiration.  This is what we did in 06 with the big coup with FFH.  However, I don't expect BRK to go up nearly as much as FFH did then.  )

 

The model for my expectations is not merely the very limited experience we have had with BRK buying its own shares below a preset limit, but the additional data points from a very similar transaction in 2006 when BRK repeatedly bought USG after their rights offering and snuffed out the short attack by our same "friends" who tried to drive Fairfax into the ground around the same time.

 

The following is all part of the public record.

 

USG's price rose way above its IV in 2006 after its POR was announced.  As part of the POR, BRK agreed to backstop their huge rights offering at $40/SH.  When the rights were issued, the shorts drove USG's price down from $120/SH to a little above $40/SH, the price BRK had agreed to backstop the rights offering.  USG's price did not reach the backstop level, and their recapitalization was completed. 

 

Not long afterward, the shorts or other holders of the expanded share base sold down USG to $45/SH. When the price dropped below $45, BRK bought USG aggressively,and the stock popped back up above $45.  The next time the stock approached $45, we bought it too. A few months earlier,we had  sold 99% of our very large USG position between $65/SH and it's peak of $120/SH after their POR had been announced.

 

There were three or four times afterward when USG approached what appeared to be a repurchase level at $45/SH. (this was not announced, but what BRK was doing was transparent because they had to report their purchases within three days as insiders).  USG's stock bounced a little bit above $45

when BRK made their first purchases below that level.  Then, USG's price would tend to rise higher after subsequent purchases as Mr. Market caught on.  It appeared that the bounces were higher after BRK was able to make significant repurchases below that threshold than when they weren't able to buy as much.

 

We did not want to hold USG because the housing market had reached its cyclical peak, so we got in a pattern of selling above $50/SH and then buying the next time it got down to $45/SH.

 

Therefore, we are now hopeful that with substantial buying of BRK below last quarter's limit, the price may rise significantly above the old and then the new repurchase limit.  :)

 

Time will tell.

[giofranchi]

Well, I really hate to sound too deferential… But I think there is a reason for it: twacowfca made me know very well LRE, which I do believe will proceed with making a lot of money for my firm in the years ahead. And he did that completely for free! Maybe, I expressed my gratitude too emphatically… But I don’t really care. It seems to me the least thing I could do! 

 

giofranchi

 

On the contrary giofranchi!!  You do not sound deferential -- you sound sincere.  And, it was your sincerity, I think, that prompted me to mention you.  So, if anyone was being deferential, it was me being so to you.

 

Frankly, while we're on the topic, your writing has been excellent on investing and your approach and thinking about owner-operators fits with much of how I try to invest.  So, thanks to you as well!

 

+1.  For the most part that's the way I've evolved also. Stick with good people, BRK,MRK, etc. Also I've found that ideas by TWACOWFCA, Parsad, Ross812, and a few others on this board have been really good with egos not getting in the way, just good rational, (About Stocks) ideas and discussions. Gio I include you too about great thoughts and discussions.

 

Kiltacular and rjstc,

really too kind of you! My financial knowledge clearly cannot even try to match Parsad’s, twacowfca’s, or Ross812’s. Anyway, I hope to bring a little perspective from the point of view of a business owner, who generates (a little) fcf and aims at making the best use of it.  :)

 

giofranchi

[twacowfca]

Here's an update on the trade.  First, the trade is in addition to our large position in the common, large because of the huge MOS.  In the first half of 2012, we added OTM Leaps when the stock price at the end of the quarter was about what we estimated 110% of BV would be once the quarter's results were reported.  These are now up about 67%. 

 

In mid December, we bought deeply ITM Leaps when the stock price was at the then announced increase in the repurchase limit of 120% of BV.  These are now up 12% to 14%, about double the increase in the stock itself since we bought them.  At the end of December, we bought a lot of slightly OTM Jan and Feb calls, as the stock price was not only below 120% of BV, but even more below what we estimated 120% of EOY BV would be.  :)

 

Recently, we've sold about half of these as they're nearing expiration for gains of 3 to 4 times what we paid.  The remainder we will probably roll over to Leaps as they near expiration.

 

What we are doing is an old hedge fund technique of identifying a trade that is almost a sure thing and then levering up.  However, unlike most hedge funds, we lever up with non recourse leverage.  :)

[onyx1]

 

In mid December, we bought deeply ITM Leaps when the stock price was at the then announced increase in the repurchase limit of 120% of BV.  These are now up 12% to 14%, about double the increase in the stock itself since we bought them. 

If your ITM LEAPS are performing like mine, they are up considerably more than the underlying,  plus more than half of the financing premium has been paid down.

 

Thanks Twa, this trade has made me happier than Eddie Money running a travel agency!  :)

[LC]

I missed my opportunity to make this trade when BRK.B was trading in the 80s and settled for buying the common instead. I surely hope another chance arises!

[twacowfca]

I missed my opportunity to make this trade when BRK.B was trading in the 80s and settled for buying the common instead. I surely hope another chance arises!

 

The trade is very asymmetric, skewed to the upside when the stock is close to or at the repurchase limit.  Time decay makes especially short term options more risky the higher above that threshold the stock is.  Leaps, particularly deep ITM Leaps, are relatively less risky than other calls, especially when the stock is significantly above the repurchase limit.

[LC]

I missed my opportunity to make this trade when BRK.B was trading in the 80s and settled for buying the common instead. I surely hope another chance arises!

 

The trade is very asymmetric, skewed to the upside when the stock is close to or at the repurchase limit.  Time decay makes especially short term options more risky the higher above that threshold the stock is.  Leaps, particularly deep ITM Leaps, are relatively less risky than other calls, especially when the stock is significantly above the repurchase limit.

I too like Leaps for this trade: however why deep ITM? I would think the time horizon of the Leaps are adequate for managing the risk that the stock takes longer to rebound. I would think ATM or slightly OTM Leaps would provide more leverage on the upside while the one-two year time provides a cushion to protect the downside. They are more prone to systematic risk I suppose. What are your thoughts?

[twacowfca]

I missed my opportunity to make this trade when BRK.B was trading in the 80s and settled for buying the common instead. I surely hope another chance arises!

 

The trade is very asymmetric, skewed to the upside when the stock is close to or at the repurchase limit.  Time decay makes short term options especially more risky the more above that limit the stock is.  Leaps, particularly deep ITM Leaps, are relatively less risky than other calls, especially when the stock is significantly above the repurchase limit.

I too like Leaps for this trade: however why deep ITM? I would think the time horizon of the Leaps are adequate for managing the risk that the stock takes longer to rebound. I would think ATM or slightly OTM Leaps would provide more leverage on the upside while the one-two year time provides a cushion to protect the downside. They are more prone to systematic risk I suppose. What are your thoughts?

 

When the stock is significantly above the repurchase limit, there is much more time decay risk because the stock could become range bound with the lower limit below the price of the stock at the time of purchase of short term calls that are especially subject to time decay  If, on the other hand short term calls were bought when the stock was at or near the repurchase limit, the likely lower bound would be very tight.  Thus any significant volatility would likely be up volatility, exactly what is wanted after buying a short term call.

 

There is much more risk if a short term call is bought when the stock is above the repurchase limit because volatility over a short time period could be downside vol as well as up vol.  ITM calls or Leaps will be much more forgiving of a little (say 5%) downside vol in that circumstance.  With a little downside vol they might only lose a little value or live to fight another day while short term ATM or OTM calls could be wiped out.  That's why we will likely be rolling our short term calls to Leaps now that the stock is significantly above the repurchase limit.  :)

 

One analyst has BRK ranked #1 or #2 of all the stocks in the S&P500.  Long term holders who wanted to sell to avoid tax increases did so before the new year.  BRK has lots of upside potential if the market isn't bearish.  :)

[twacowfca]

I missed my opportunity to make this trade when BRK.B was trading in the 80s and settled for buying the common instead. I surely hope another chance arises!

 

The trade is very asymmetric, skewed to the upside when the stock is close to or at the repurchase limit.  Time decay makes short term options especially more risky the more above that limit the stock is.  Leaps, particularly deep ITM Leaps, are relatively less risky than other calls, especially when the stock is significantly above the repurchase limit.

I too like Leaps for this trade: however why deep ITM? I would think the time horizon of the Leaps are adequate for managing the risk that the stock takes longer to rebound. I would think ATM or slightly OTM Leaps would provide more leverage on the upside while the one-two year time provides a cushion to protect the downside. They are more prone to systematic risk I suppose. What are your thoughts?

 

When the stock is significantly above the repurchase limit, there is much more time decay risk because the stock could become range bound with the lower limit below the price of the stock at the time of purchase of short term calls that are especially subject to time decay  If, on the other hand short term calls were bought when the stock was at or near the repurchase limit, the likely lower bound would be very tight.  Thus any significant volatility would likely be up volatility, exactly what is wanted after buying a short term call.R

 

There is much more risk if a short term call is bought when the stock is above the repurchase limit because volatility over a short time period could be downside vol as well as up vol.  ITM calls or Leaps will be much more forgiving of a little (say 5%) downside vol in that circumstance.  With a little downside vol they might only lose a little value or live to fight another day while short term ATM or OTM calls could be wiped out.  That's why we will likely be rolling our short term calls to Leaps now that the stock is significantly above the repurchase limit.  :)

 

One analyst has BRK ranked #1 or #2 of all the stocks in the S&P500.  Long term holders who wanted to sell to avoid tax increases did so before the new year.  BRK has lots of upside potential if the market isn't bearish.  :)

 

Having said all that, we did otherwise, rolling our expiring January options into February calls because they were dirt cheap and because the distribution of the IV for the different strike prices of calls is favorable for increase the more an OTM call moves toward being ATM or ITM, the opposite of the tendency for a "smile" pattern to manifest since the financial crisis with puts.

 

We took most of the money off the table, but still doubled the notional exposure of the short term calls.  :)

[twacowfca]

An interesting, although obvious statement by Taleb seems apropos this trade: "A stochastic process subject to an absorbing barrier will have an observed mean higher than the barrier.". :)

[LC]

 

Having said all that, we did otherwise, rolling our expiring January options into February calls because they were dirt cheap and because the distribution of the IV for the different strike prices of calls is favorable for increase the more an OTM call moves toward being ATM or ITM, the opposite of the tendency for a "smile" pattern to manifest since the financial crisis with puts.

 

If I am understanding this correctly, you're saying the IV of the OTM calls has more upside than ATM/ITM calls of the same date/strike?

 

How far OTM did you go if the strike is only 1 month out? Or are you planning on continuously rolling contracts over on a monthly basis as long as nothing systematic happens in the market? If not, why not just purchase 2015 LEAP OTM calls?

 

[twacowfca]

 

Having said all that, we did otherwise, rolling our expiring January options into February calls because they were dirt cheap and because the distribution of the IV for the different strike prices of calls is favorable for increase the more an OTM call moves toward being ATM or ITM, the opposite of the tendency for a "smile" pattern to manifest since the financial crisis with puts.

 

If I am understanding this correctly, you're saying the IV of the OTM calls has more upside than ATM/ITM calls of the same date/strike?

 

How far OTM did you go if the strike is only 1 month out? Or are you planning on continuously rolling contracts over on a monthly basis as long as nothing systematic happens in the market? If not, why not just purchase 2015 LEAP OTM calls?

 

There is more upside if the underlying increases in price.  Then, the IV of the OTM call should increase as the strike price approaches being ATM or ITM.  However, if the price of the underlying doesn't advance, there is no downside to the convexity because it won't matter what the IV is if the short term call expires worthless or near worthless.

 

We added to our 95 strike Feb 13 when it was slightly OTM and also picked up the $97.50.  These were cheap, and it won't require a big move for an asymmetrical payoff.  Well worth the risk of a mostly total loss IMO.  :)