The Mother of All Easy Trades

[bmichaud]

Twa,

 

If you don't mind me asking, what % of AUM are these near-term option trades? Is this a scalable strategy for say a Bruce Berkowitz with $8B under mgmt or even WEB back in the early BRK days?

[twacowfca]

Twa,

 

If you don't mind me asking, what % of AUM are these near-term option trades? Is this a scalable strategy for say a Bruce Berkowitz with $8B under mgmt or even WEB back in the early BRK days?

 

It's probably not very scalable for a large fund .  I like it in IRA's, because there is no tax on short term gains.  We 're all friends and family so it's fun to play around with, but the short term calls are very speculative now because the repurchase limit being five percent below the market price isn't much of a floor with a short term horizon.  What's worked extremely well though in absolute gains is the leaps.  These are scalable for the size of our accounts.  Owning the leaps has given us great leverage compared to merely owning the common.  The repurchase limit still being only five percent below the price of the common is quite important for the MOS of owning the leaps because of the long time horizon.  Plus, we don't have to pretend we're traders.  We can sleep on the leaps.  :)

[LC]

Plus, we don't have to pretend we're traders.  We can sleep on the leaps.  :)

Hah! If I were to stare myself in the mirror and ask why I like LEAPs more than almost any other instrument, this would be it. The only exception would be warrants, although it's a close tie given the leverage LEAPs provide.

[bmichaud]

Twa,

 

If you don't mind me asking, what % of AUM are these near-term option trades? Is this a scalable strategy for say a Bruce Berkowitz with $8B under mgmt or even WEB back in the early BRK days?

 

It's probably not very scalable for a large fund .  I like it in IRA's, because there is no tax on short term gains.  We 're all friends and family so it's fun to play around with, but the short term calls are very speculative now because the repurchase limit being five percent below the market price isn't much of a floor with a short term horizon.  What's worked extremely well though in absolute gains is the leaps.  These are scalable for the size of our accounts.  Owning the leaps has given us great leverage compared to merely owning the common.  The repurchase limit still being only five percent below the price of the common is quite important for the MOS of owning the leaps because of the long time horizon.  Plus, we don't have to pretend we're traders.  We can sleep on the leaps.  :)

 

Thanks TWA  ;D

[onyx1]

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.  :)

 

Well that didn't take long, looks like your 97.5's have doubled, way to go TWA!

[twacowfca]

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.  :)

 

Well that didn't take long, looks like your 97.5's have doubled, way to go TWA!

 

Thanks, Wayne.

 

BRK has a lot of tailwinds.  Nevertheless, we've reduced the VAR by taking money off the table as the stock gets increasingly above the repurchase limit at the same time we've increased the notional exposure.  :)

 

Feb 24, update

 

We happily had the opportunity a few days ago to take advantage of the little bounce around the expiration date that coincided with the announcement of the Heinz acquisition.  We closed out all our short term calls as the stock is now about 10% above the repurchase limit.  However we continue to hold the common and leaps.  This investment/trade has worked out almost as well as the awesome Fairfax short squeeze in 2006.  The price movement of BRK has been less, but we have put a lot more into BRK than we added to FFH in leaps in 2006 because of the high MOS as a consequence of the Buffett "put".    :)

[twacowfca]

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.  :)

 

Well that didn't take long, looks like your 97.5's have doubled, way to go TWA!

 

Thanks, Wayne.

 

BRK has a lot of tailwinds.  Nevertheless, we've reduced the VAR by taking money off the table as the stock gets increasingly above the repurchase limit at the same time we've increased the notional exposure.  :)

 

Feb 24, update

 

We happily had the opportunity a few days ago to take advantage of the little bounce around the expiration date that coincided with the announcement of the Heinz acquisition.  We closed out all our short term calls as the stock is now about 10% above the repurchase limit.  However we continue to hold the common and leaps.  This investment/trade has worked out almost as well as the awesome Fairfax short squeeze in 2006.  The price movement of BRK has been less, but we have put a lot more into BRK than we added to FFH in leaps in 2006 because of the high MOS as a consequence of the Buffett "put".    :)

 

Feb 24 update above.

[Shane]

twacowfca,

 

I've followed you into this trade with in the money LEAPS.  I'm wondering how your feeling about the LEAPS at these prices.  At 1.4x BV and the market in the middle(end?) of a strong run, I am seriously considering selling the LEAPS.... however, the unfortunate consequences of making a lot of quickly are short-term capital gains taxes!

 

 

[jay21]

twacowfca,

 

I've followed you into this trade with in the money LEAPS.  I'm wondering how your feeling about the LEAPS at these prices.  At 1.4x BV and the market in the middle(end?) of a strong run, I am seriously considering selling the LEAPS.... however, the unfortunate consequences of making a lot of quickly are short-term capital gains taxes!

 

If you take delivery, do you incur any taxes?

[ericd1]

Not until you sell the shares.

[Homestead31]

curious what people's opinions are here on the LEAPs.  P/B is ~1.4x, so not as cheap as it was when this thread was really humming a few years back (P/B was ~1.2x at the time), but at the same time, volatility is at record lows, making the options cheaper.

 

any and all thoughts appreciated.

[TwoCitiesCapital]

curious what people's opinions are here on the LEAPs.  P/B is ~1.4x, so not as cheap as it was when this thread was really humming a few years back (P/B was ~1.2x at the time), but at the same time, volatility is at record lows, making the options cheaper.

 

any and all thoughts appreciated.

 

If you're buying because vol is low instead of the stock being cheap, it's probably best to consider purchasing the volatility aspect while keeping exposure to the stock neutral.

 

The vol component of the option is dominated by the movements of the underlying stock. Even if vol goes up, you could lose just because the stock goes down to 1.3 - 1.35x book (depending on your strike price).

 

If you're making a bet that volatility is likely to rise over that time, buy a put and a call at the same strike for a year out. Doesn't matter what the stock does - if realized vol is higher than the combination of implied vol and the to-date time decay, you'll make money.

 

This trade might have made sense without hedging the vol because the underlying stock moves were likely to dominate that aspect of the trade. It doesn't necessarily work as well in reverse.

[Homestead31]

thanks twocities

 

to be clear, i still think the stock is cheap, but not AS cheap.  When it was at 1.2x there was theoretically no downside to the buyback level (which obviously isn't guaranteed).  Now, at 1.4x there is ~17% downside to the buyback level. 

 

however, it may worth considering that while the stock is now technically at ~1.4x book, the market value of KHC is not captured by book value.  adjusting for this gets you closer to ~1.3x book.  This just one of those crazy GAAP things, and we know how Buffett feels about that... so maybe 1.2x isn't the buyback level. maybe now it is 1.3x.  impossible to know.  also worth noting that book value could also be adjusted based on the potential for a change in tax rates, as deferred tax liabilities would be reduced if trump is able to lower corporate tax rates.  that combined with book value growing every day as cash pours into Omaha, and we're probably not all that far off from the 1.2x BV level that BRK was at a few years ago when this thread was popular.

 

anyway, i haven't historically invested in LEAPs, but i remembered this thread was interesting so i wanted to revive it.

 

it seems like in the money LEAPs would have good risk/reward here

[TwoCitiesCapital]

thanks twocities

 

to be clear, i still think the stock is cheap, but not AS cheap.  When it was at 1.2x there was theoretically no downside to the buyback level (which obviously isn't guaranteed).  Now, at 1.4x there is ~17% downside to the buyback level. 

 

however, it may worth considering that while the stock is now technically at ~1.4x book, the market value of KHC is not captured by book value.  adjusting for this gets you closer to ~1.3x book.  This just one of those crazy GAAP things, and we know how Buffett feels about that... so maybe 1.2x isn't the buyback level. maybe now it is 1.3x.  impossible to know.  also worth noting that book value could also be adjusted based on the potential for a change in tax rates, as deferred tax liabilities would be reduced if trump is able to lower corporate tax rates.  that combined with book value growing every day as cash pours into Omaha, and we're probably not all that far off from the 1.2x BV level that BRK was at a few years ago when this thread was popular.

 

anyway, i haven't historically invested in LEAPs, but i remembered this thread was interesting so i wanted to revive it.

 

it seems like in the money LEAPs would have good risk/reward here

 

I use LEAPS regularly - but not because of my views on volatility, but because of my views on the underlying. All the volatility premium plays into is the cost of financing - does it make more sense to leverage using LEAPS, margin, a mortgage, etc? It does not provide a reason to enter the position/leverage to begin with simply because movements in the underlying will dominate movements in vol.

 

That was my only point because it sounded like your interest in LEAPS was due to the low volatility premium and not necessarily a view on the near-term prospects for the name. Was just adding my 2 cents.

[netnet]

Playing devil's advocate here, but are LEAP's prudent when the overall market is so high, i.e. should there be a big correction it would probably affect BRK; (And the BV of held securities would fall as well.)  You admittedly have the Buffett put, but suppose upon a crack up, he sees an investment that is 'better' than buying BRK at 1.2 (or say 1x on the old book?) 

 

In the depths of the great recession, BRK was down 50%, what was the P/BV then?

 

[johnny]

YE2008 A share BV was 70K, 2007 was 78K.

 

So it went from >1.6x to just about 1x in that year.

[Paarslaars]

Playing devil's advocate here, but are LEAP's prudent when the overall market is so high, i.e. should there be a big correction it would probably affect BRK; (And the BV of held securities would fall as well.)  You admittedly have the Buffett put, but suppose upon a crack up, he sees an investment that is 'better' than buying BRK at 1.2 (or say 1x on the old book?) 

 

In the depths of the great recession, BRK was down 50%, what was the P/BV then?

 

Indeed, Buffet has also made it clear he will not use buy-backs as a price floor in a weak market.

[Liberty]

Indeed, Buffet has also made it clear he will not use buy-backs as a price floor in a weak market.

 

If he has better opportunities to deploy lots of capital, it would be crazy to tie his hands in advance to buybacks. If BRK falls a lot, other things are probably falling even more.

[Homestead31]

all true about the 1.2x theoretical buybacks.  it is NOT written in stone.

 

it also wasn't written in stone a few years ago when this thread was popular and a lot of guys made a lot of money with the BRK LEAPS.

 

fully understanding that the 1.2x "buffett put" is at best nebulous, does anyone have any views on BRK LEAPS today?

 

on the surface it seems that BRK is not as cheap as it was in '13 when this thread was popular.. but maybe it is?

 

and on the surface the options are cheaper, but does that matter if the stock is not as cheap?