Berkshire, once again, laboring under the cloud of the long dated index puts the firm has sold, has hit five year lows. The fear is that collapsing indexes, against which Berkshire has written a number of long dated puts to unknown counterparties (-cough- Goldman -cough-) will cause writedowns in the coming quarterlies. True, Berkshire doesn’t have to pay out on these instruments until 2019 at the earliest, but that’s not stopping the panic and it drove Berkshire Class A shares down to $73,677.30 this afternoon. Shares have since recovered some, but the cloud lingers.
As we’ve mentioned before, the options are European style (i.e. cannot be exercised before the expiration date) and Berkshire is apparently not required to put up collateral based on the price of the options or their underlying, but rather only in the event the firm itself suffers some sort of impairment. (There aren’t a lot of details here, but we suspect this means a credit downgrade or a significant cash crisis). In a way, this has made Berkshire stock a proxy for global index expectations. Insofar as Charlie and Warren don’t care about stock price, this probably doesn’t mean much- except that now might be a good time to buy back some stock.
Buffett’s Berkshire Drops to Lowest in Five Years [Bloomberg]
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- Use the Bloomberg command
NH BLG_DEALBREAKER <GO>
to access Dealbreaker
This was still a brilliant trade.
How much premium did Buffett get? And he can invest that until 2019. Hell, even if it’s in Treasuries until 2019 it’s going to generate a LOT of income.
What’s insane is that idiot commentators talk about the notional value. Right, that is relevant if the indexes are zero in 2019.
A more relevant (but still silly) measure would be against the index value today. Any clue on the size of that payout relative to premium.
Of course all of the presumes Buffett hasn’t hedged this (he may not have), and that the market doesn’t rise enough to put on a hedge sometime between now and 2019.
We can worry about this puppy in about 5 years.
I agree with Buffett.
didn’t buffett call derivatives “financial weapons of mass destruction”? seems to me that gramps should have eaten some of his own cookin’…would be interesting to see what the strike was on those bad boys. at the end of the day, he’s playing with 1′s and 0′s – not to mention, he has the benefit of time and liquidity on his side (and no requirements for collateral – if only we could all get those sweet terms).
@ cluzo
“he” doesn’t necessarily have the time, the company might, but ol’ Buffs might not be around to see the fruits of his labour
“Posted by Anal_yst, Feb 20, 2009 4:26PM
@ cluzo
“he” doesn’t necessarily have the time, the company might, but ol’ Buffs might not be around to see the fruits of his labour”
One more reason the trade was genius. Cash now. Liability- after I’m dead.
I believe he used them to finance the buyout of $4B of a group of companies, if my memory of bschool case studies serves me correctly. Not sure if that is the total deriv amount though.
There’s no “cash now”; the money used in writing puts will be used to collateralize his trade and held by the prime broker. In fact, he will likely post additional margin against the trade.
Nice try.
bullshit genius. the premium level he got is for chumps. i can get that on PG. and the strikes are 145-150. the man lost it pure and simple. can be seen from other trades he made in the last 10 months.
@7
No collateral required.
I read the premium was $4B, so he has $4B to invest for 10 years. As 9 points out (and EP herself mentions) no collateral is required (try reading, 7).
Geico definitely has some derivatives going on in that book, so yeah, Buffett is a bit of a hypocrite.
On the other hand selling long-dated uncollateralized European-style index options are about as vanilla as one can get in the world of derivatives.
The end result? Yeah, Berkshire does have a somewhat higher beta as long as the indexes are down here – but maybe not as much as a company that’s all levered to hell with debt coming due next year.
“Posted by guest, Feb 20, 2009 4:31PM
There’s no “cash now”; the money used in writing puts will be used to collateralize his trade and held by the prime broker. In fact, he will likely post additional margin against the trade.
Nice try.”
All false.
@1 BRK got $5B for $40+B of exposure much of which would have to be paid out if current market levels hold. Treasuries aint getting him the return to cover that. There is a definate possibility (which is becoming a probability) that he will lose several billion on this trade. He is also going to take a bath on the $5B of high yield CDS exposure he has. He forgot that derivatives are weapons of mass destruction….
He is also going to get downgraded if the market takes another 20+% whack. If he loses his triple A, ruh-roh…
Disclosure, I’m short BRK since October.
I bought Brk today.
Just read 80 pounds of cocaine seized. There goes the weekend.
(note: not racist)
#12: So what if he losses a few billion on the trade? how much does a big P&C company lose on a bad hurricane? His CDS exposure is related to his muni insurance business not HY.
I really just want some dairy queen right now, like whoa, that’s all i’ve got to add to this discussion
Anal,
Totally agree. I was trying to think of some DQ Blizzard reference/joke, but, alas…I got nothin’.
@15 – his CDS exposure is not related to his muni insurance business. It is related to high yield securities. Read his recent 10-Q and K and stop spewing nonsense about things you know nothing about.
Also, he’s still in the reinsurance business you dope – so if we have a huge catasrophic event like a Katrina he’l get doubly whacked.
No to mention that the building products exposure in his company portfolio is epic….
Being long BRK has been a disaster.
@12 Why the disclosure…you’re a guest, you’re incognito, nobody knows who you are…in fact I could be you right now…What the fuck.
Disclosure: I’m short deez
That’s my point… Why are people worried about a small amt of exposure to CDS and equities when the real risk is in his insurance book which is many mulitples of any likely payout of 10 year puts and cds?
Is anyone a little concerned that the great WB made a trade with “maybe” GS or for that matter anyone with the NEED for 40b nominal protection 20yrs out? Who do you think has the best valuation models? Who do you think would have the best handle on a transaction of this nature?
How do you value a 20 year option so that both parties accept the terms? Premium levels would give the purchaser about 1:400 the protection available nearer term and if it was too cheap you would hope the great WB would be smart enough not to accept the price and ask for more.
OTC trade, no disclosure and hmmmmm 5 years later we are at or through the US Index strike and probably way way through the other global Major Market Index strikes…
Further if WB owes GS the Difference between the 40b+ nominal and the new value of the Puts what is the CDS market on him blowing out the investment he just made in GS? Was it a loan? What was it anyway if GS actually holds the long puts?
How did we get in to this mess…? Oh yeah Leveraging and asset that we own that was Leveraged by someone else who already leveraged it 2x’s.
See any similarities?
Stinks to high heck … my call WB made the worst trade ever and if he slips this noose without going to jail for nondisclosure it’s because he maintains friends in high places.
To be continued…
@15 – I believe it’s more than just a few billion related to said contracts…as for p&c companies, they are paid premiums ANNUALLY to cover potential losses. not to mention, he takes his big bets in reinsurance (making him a second loss position) where ROL’s are close to 25%. then you have include the fact that, after a big event, most contracts include a clause for reinstatement premium and the ROL for the next year could double further reducing his loss.
Equity Private,
If you are selling vanilla put options, you need to collateralize the trade somehow. Either you have enough margin in your existing account or you post. Say you opened a new account with a prime broker on the Street. You can’t sell put options willy-nilly; their risk department would have a heart attack. You would be subject to either portfolio margining, which requires your portfolio to be a certain size, or Reg T, which would mean you post additional margin against your trade and/or you collateralize with the premiums.
Just like with CDS where you need to maintain a certain NAV of your fund or you trip your ISDA.
Look people:
It is a big umbrella from BRK and GS to slowly float as the rest of the market collapses as they share the most credit worthy counter party tag from Moody’s (A WB company) and S&P (I forget their scale).
When they are scooping up all the stuff you people are forced to sell in a year, don’t forget you heard it here first.
@23 does any of this apply to warren Buffett or are you just explaining to ep how she can setup her own option account?
Buffets options are not plain vanilla and are long term, European puts with very customized collateral/margin reqs which I think munger said were based on brk’s ratings, ie no collateral unless they lose the aaa (someone might need to doublecheck me on the collateral req details)
I was just talking about vanilla puts, not BRK’s deal. Like if EP were to trade options in his/her hedge fund. I’ve had this conversation with my PB ad nauseum and it’s a frustrating one.
@26 – it’s frustrating that your PB wants you to post collateral on a short options position?
Is that seriously what you are saying? If it is, you are exactly the reason we’ve gotten into this mess in the first place.
Um…unless your initials are WB and you run a firm with $44B of cash on hand.
“Equity Private,
If you are selling vanilla put options, you need to collateralize the trade somehow. Either you have enough margin in your existing account or you post. Say you opened a new account with a prime broker on the Street.”
I think you need to study the Berkshire Options.
What’s missing in the discussion is an examination of his dogshit portfolio of big name stocks.Stocks so stupendous that he’ll never sell because he’s always smarter than the market, or so he thinks.He’s getting whacked in every sector, with his consumer non durables now coming apart.Remember,raincoat Warren always loved to say the market was soooooo rich he couldn’t buy stocks, then went out and bought a ton, some right at the top after they’ve hit peak cyclical earnings.Gosh, you’d think he’s some pleb fund manager chasing returns….
Du bist ja eine ganz schlaue, EP ;)
#28, the frustrating part is when the PB’s risk department changes their requirements all the time, not that they require posting collateral. Or getting them understand the true risk of a spread bet (e.g., buying/selling put and call spreads on the same option), which have limited risk/reward since I’m long and short the same name. They can be arbitrary about it.
#29, understood. I don’t know how Buffett structured the bet.
disclosure: long vanilla, short dogshit.
All you can eat Buffett at the DQ.
buffet must be sporting a half pack of rolos in his pocket with so many people still riding his nuts despite his recent trades
We need Liz Claman to get back out to Omaha to get his heart pumping faster again. That’s the only way he’ll be able to deal with the deriv nightmare. He lives for her. So do i for that matter.
From his 2008 annual report
****
The second category of contracts involves various put options we have sold on four stock indices (the S&P 500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were struck at the market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of $4.6 billion. The puts in these contracts are exercisable only at their expiration dates, which occur between 2019 and 2027, and Berkshire will then need to make a payment only if the index in question is quoted at a level below that existing on the day that the put was written. Again, I believe these contracts, in aggregate, will be profitable and that we will, in addition, receive substantial income from our investment of the premiums we hold during the 15- or 20-year period. Two aspects of our derivative contracts are particularly important.
First, in all cases we hold the money, which means that we have no counterparty risk.
Second, accounting rules for our derivative contracts differ from those applying to our investment portfolio. In that portfolio, changes in value are applied to the net worth shown on Berkshire’s balance sheet, but do not affect earnings unless we sell (or write down) a holding. Changes in the value of a derivative contract, however, must be applied each quarter to earnings.
*******
Disclosure I’m a huge admirer of Buffett. Even going back to his hedge fund days in the 50′s he had the quality I believe is most important to an investor- the ability to ignore the maddening crowd. Time after time he was called an idiot or worse, during the recession in 1958, the downturn in 1960, getting out of the market in 1969 and 1987(though people changed their minds sharpish) and of course ignoring for the internet hoopla of the late 90′s. I actually enjoy going back and reading the stories in Fortune and Time calling him a has been for ignoring such great opportunities as pets.com. In comparing the wisdom of Warren Buffett and Daniel Kudlec I think I’ll stick to Warren
http://www.time.com/time/magazine/article/0,9171,1101000515-44525,00.html
Final thought in 1975 his portfolio had lost 33%, the washington post company had gone down 25% almost immediately after he bought ~11 million dollars worth. He managed to ignore the pollyannas of doom and that investment is now worth 1.7 billion dollars not counting the rich dividends over the years.
One more comment. Reading the junk media’s take on Warren Buffett captures the provocative but rarely the essence. His take on derivatives came after his unwinding of the General Re positions as he details in his 2003 annual report which in summary was that valuing a derivatives rich company is difficult. Made worse when the employees on both sides of say a 100 year contract can write it to mark it as profit and hence a bonus for said employees.
Any weapon is dangerous in the wrong hands. I believe his perspective on derivatives is captured more clearly in the 1989 letter one of the better ones on EBITDA and zero coupon financing and Investment Bankers:
********
Whatever their weaknesses, we should add, many zero-coupon and PIK bonds will not default. We have in fact owned some and may buy more if their market becomes sufficiently distressed. (We’ve not, however, even considered buying a new issue from a weak credit.) No financial instrument is evil per se; it’s just that some variations have far more potential for mischief than others.
http://www.berkshirehathaway.com/letters/1989.html
&36…..I am in line right behind you….Love La Liz.
Given simple mortality tables, Buffet’s gonna be dead or certainly not running BRK by 2019. The notion of WB not running the firm will have a much greater impact on the equity than these puts… and there’s a 100% chance of this happening.
I thought Buffet just did music? I didn’t know he was into stocks too.
@41,,,yeah me too, like where’s his lost shaker of salt?
some people say that there’s a woman to blame…
This is the most idiotic uninformed thread ever.
BRK is getting crushed because their largest capital holdings are in the financial services sector.
Wells Fargo, General Electric, Goldman Sacks, GEICO, General Re, Wesco Finacial, American Express all are sitting on boatloads of toxic paper such as mortgage backed CDOs and worthless CDSs.
#32 Good luck arguing margin levels on listed options with your PB. A lot of them — maybe all — use the OCC’s (the Option Clearing Corporation) methodology for determining capital requirements, though I am not sure if they do it because it’s an OCC clearing member requirement, or just because it’s convention. Looking at their website, they seem to indicate that it’s part of the SEC’s net capital rule.
The capital requirement number is calculated by an OCC system that re-values every option at 10 different market moves, 5 up, 5 down at 3% intervals if I recall correctly. I am not sure how exactly they deal with the skew, but they move the vols as well for each move, and then re-calculate the option’s price. These theoretical values are then distributed to PBs daily for use with their client portfolios.
They then net your winners and losers for a given underlying/move, take the worst move for each underlying, sum them up, and that’s your requirement. There are some additional rules like .25 / option minimum and some allowances for netting stock baskets against index positions, but probably you’re going to get roughly the same number everywhere, though I’m sure that some places charge a little more on top, just to be safe. Especially for smaller clients or retail accounts.
WB’s puts, on the other hand, are not cleared by the OCC, so not subject to the same restrictions (and also not backed by anyone other than the full faith and credit of BRK). So if you were on the other side of the trade, and looking at some large theoretical gains, you may want / need to hedge some of your credit exposure on these theoretical gains. It has been remarked that BRKs CDS did have an unusual spike a few months back, but you can draw your own conclusions about that.
#32 Good luck arguing margin levels on listed options with your PB. A lot of them — maybe all — use the OCC’s (the Option Clearing Corporation) methodology for determining capital requirements, though I am not sure if they do it because it’s an OCC clearing member requirement, or just because it’s convention. Looking at their website, they seem to indicate that it’s part of the SEC’s net capital rule.
The capital requirement number is calculated by an OCC system that re-values every option at 10 different market moves, 5 up, 5 down at 3% intervals if I recall correctly. I am not sure how exactly they deal with the skew, but they move the vols as well for each move, and then re-calculate the option’s price. These theoretical values are then distributed to PBs daily for use with their client portfolios.
They then net your winners and losers for a given underlying/move, take the worst move for each underlying, sum them up, and that’s your requirement. There are some additional rules like .25 / option minimum and some allowances for netting stock baskets against index positions, but probably you’re going to get roughly the same number everywhere, though I’m sure that some places charge a little more on top, just to be safe. Especially for smaller clients or retail accounts.
WB’s puts, on the other hand, are not cleared by the OCC, so not subject to the same restrictions (and also not backed by anyone other than the full faith and credit of BRK). So if you were on the other side of the trade, and looking at some large theoretical gains, you may want / need to hedge some of your credit exposure on these theoretical gains. It has been remarked that BRKs CDS did have an unusual spike a few months back, but you can draw your own conclusions about that.
Buffet made a great call buying the market in october….dow theory confirmed a bear primary trend and the 50% Principle broke at 7470. What is the 50% Principle? Pick up a book…
Buffet made a great call buying the market in october….dow theory confirmed a bear primary trend and the 50% Principle broke at 7470. What is the 50% Principle? Pick up a book…
the 50% principle –> look at your 401K and you have left is 50% of the principal you put in.
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