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April 2008

Recs

6

Buffett Writing Index Puts

April 29, 2008 – Comments (7) | RELATED TICKERS: KO , BRK-A , SPY

This is the put buffett wrote its on page 47 of the latest 10-k link here.

"Equity Price Risk (Continued)
     Berkshire is also subject to equity price risk with respect to certain long duration equity index option contracts. Berkshire's maximum exposure with respect to such contracts was approximately $35 billion and $21 billion at December 31, 2007 and 2006, respectively. These contracts generally expire 15 to 20 years from inception and they may not be settled before their respective expiration dates. The contracts have been written on four major equity indexes including three that are based on foreign markets. While Berkshire's ultimate potential loss with respect to these contracts is directly correlated to the movement of the underlying stock index between contract inception date and expiration, the change in fair value from current changes in the indexes do not produce a proportional change in the estimated fair value of the contracts. Other factors (such as interest rates, expected dividend rates and the remaining duration of the contract as well as general market assumptions) affect the estimates of fair value reflected in the financial statements. The carrying amount of these liabilities was $4.6 billion at December 31, 2007 and $2.4 billion at December 31, 2006. If the underlying indexes declined 30% immediately, and absent changes in other factors required to estimate fair value, Berkshire estimates that it could incur a non-cash pre-tax loss of approximately $2.3 billion."

To me these look like a barrier option with a time constraint, e.g. a put that only that is only active if the price of the index hits a certain strike price within a certain time frame, (like the S&P has to move down 30% in a 1 week period) from what I hear from people Buffett got a bunch of investment banks together that were really scared about a market crash, and wrote the put. Which is smart because if the markets moved more than something like 10% they would shut down trading and we have never seen a one day crash of more than 22.5%.  He got something like 4 bil in premium.

What most people do not know or at least talk about is that Buffett obtains most of his stock holdings through selling puts.  He got most of his Coca-Cola Holdings this way as many other's.  Since he is kind of constrained to buying large cap companies most of which have options traded on them that have decent volume he sells a lot of puts.  Also through my own research I know that puts on larger cap companies tend to expire worthless more often than puts on mid cap companies.  Also in options theory puts are more expensive than calls in general.  There are several reasons for this the main one being that if you want to short a stock you have the pay the dividend's to the person you sell the stock too also you have to pay interest on the borrowed shares, hence puts in theory are more expensive than calls.  This kind of works itself out because stocks tend to drop 5x faster than they rise (don't get my started talking about options lol)

Thought you all might find this interesting.  [more]

Recs

3

Models used in valueing some of this debt.

April 13, 2008 – Comments (1) | RELATED TICKERS: XLF , SKF , SRS

How it is accounted for, the rules are changing.  I would like to get you all thoughts.

Recs

5

Ok Ok I Confess

April 12, 2008 – Comments (2) | RELATED TICKERS: CHDN , LMT , NOC

Yes I have been busy with a lot of things. 

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