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TMFPostOfTheDay (< 20)

The "Optionality" of Cash



December 23, 2013 – Comments (5) | RELATED TICKERS: BRK-A

Board: Berkshire Hathaway

Author: commoncents33

In the past couple weeks on this board (IIRC), someone made reference to the optionality of cash. Although it is likely obvious to many here, it was an epiphany for me. Thank you, to whoever that was.

Especially at times like this, when cash is yielding near zero in nominal terms, and negative in real terms, holding it seems toxic.

Yet, if one understands that the value of cash is composed of the combination of: 1) the interest earned, and 2) the value it has to put a big ole bat on the fat pitch when it eventually comes, then holding it seems much more attractive.

Here is a link that has an interesting graph comparing the outcome of investing in the SP500 in 2004 (when it seemed reasonably priced) vs. holding cash only yielding 1%...and then buying the SP500 at the bottom in 2009. Quite a difference in reward! True, it would be very difficult sitting on all that cash all the way to the bottom in 2009; nevertheless, the point is well-taken. Moreover, the option at that bottom wasn't just buying the SP500; there were all sorts of absurdly-cheap individual stocks (was there anyone else besides me wishing they had cash to put into Lucadia at $10?). Even more explosive would have been someone with the conviction to buy call options on some of the casualties; I imagine there were quite a few ten-baggers to be had without getting too crazy on the business, strike price, or duration (e.g. LEAPs on solid Leucadia).

Here's that link:

Some other useful links:
He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

5. “Financial options may be expensive because people know they are options and someone is selling them and charging a price—but most interesting options are free, or at the worst, cheap.” Some of the most important options are not obviously financial in nature and for that reason are not labeled as “options.” In those cases it is more likely that you will be able to purchase or acquire a mispriced option since other people often don’t understand what is involved (e.g., investment bankers have cheap options since losses are socialized when huge).

6. “Make sure the optionality is not priced by the market.” It is possible to overpay for optionality. For example, what venture capitalist Bill Gurley called “frothy trades in the bubbly late stage private market” in 2011 is a great example of overpaying for optionality.
Do not underestimate the value of doing nothing" said Winnie The Pooh

With the overall market quite richly valued, it is very tempting to buy puts on something which seems absurdly priced, such as AMZN or TLSA. Yet to profit there, you have to be right about 1) the overvaluation of the business, 2) the magnitude of the potential fall for that specific business, and worst of all 3) the timing of the fall. That is trying to jump over a seven-foot bar. Instead I'm going to step over a 1-foot bar: raise cash, then just wait. For the fat pitch. Maybe the market will crash, offering up an enormous number of fat pitches. Or maybe just one business I understand will get trashed by Mr. Market. No hurry. As the cash-option has no expiration and is good for any business, the only necessary ingredients are patience, judgment, and courage. 

5 Comments – Post Your Own

#1) On December 23, 2013 at 12:29 PM, awallejr (38.93) wrote:

Or you can do both.  Set aside cash and invest in things yielding you more than CDs or Tbills.  As for a strong correction, yup I do see that in the cards.  I am just not sure when. 

I read that a bull market has 3 legs.  First leg is when you could throw a dart at stock charts and couldn't go wrong.  Second leg is where market rises steady but you have to be more picky.  Third leg is when it becomes a "stock picker's" market.  I have been hearing that a lot lately (meaning it is now a "stock picker" market).


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#2) On December 23, 2013 at 3:22 PM, rd80 (94.78) wrote:

and then buying the SP500 at the bottom in 2009.

The trick, of course, would have been knowing that the index had bottomed. :)


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#3) On December 24, 2013 at 10:47 AM, captainccs (35.71) wrote:

There is no doubt that cash makes a portfolio more robust while leverage makes it more efficient and more fragile. But from there to jump to the conclusion that had you had cash on March 9, 2009, you would have spent it all on stocks is a totally unwarranted conclusion. The level of fear in markets was such that most investors were paralyzed.

I've been looking at price charts for years and the view in hindsight is radically different from the view of the same event in real time.

Denny Schlesinger 

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#4) On December 25, 2013 at 1:04 PM, constructive (99.96) wrote:

"He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

The problem here is that cash is obviously a mild put option (benefiting when assets decline), not a call option. If someone can't get that right, I wonder whether they have anything useful to say about the optionality of cash.

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#5) On December 26, 2013 at 9:07 AM, MKArch (99.76) wrote:

I definitely see the point about having a pile of cash handy at the bottom of a cycle as I was wishing I had a pile of cash to deploy early 1999. I had the opposite problem that captainccs mentioned, I saw the opportunity but could only redeploy what was left of my current investments in what looked like the best opportunities at the time. A strategy that I use in more normal times is too evaluate new opportunities against what I already own and trim holdings or even sell altogether if the new opportunity looks promising enough. I'm not a trader so the opportunity has to be compelling and I think hard about making the move however the point is you don't necessarily need to have a pile of cash sitting idle waiting for an opportunity to be deployed.

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