Lightening notes

There is no need to lighten up when valuations get towards the high end of their range.
But if one wanted to, I note that it might not be such a bad time to write some covered calls.
i.e., write a call option to add to a current long position, which is conditionally selling some stock.

e.g., January 2023 $340 calls are trading at $29.

Various outcomes:

(1)
The stock remains this high or higher till year end.
Your stock gets called away at a net exit price of $369/B = $553500 per share.
That’s 1.629 times currently known book per share.
Intrinsic value per share probably won’t rise more than 5% by then.
So, not such a bad outcome. If you were thinking of lightening up anyway, that’s a pretty good valuation level.

(2)
The stock price pulls back and stays there.
You keep the $29 premium.
About 8.6% profit in 309 days, which is about 10.1%/year rate annualized linearly.
And that’s money you would not otherwise have had, also not so bad.

(3)
The stock falls for a while at some point this year, but rebounds and ends up high by next January.
This might be the most common situation—prices fluctuate.
You pay attention during any price plunge, and close the covered calls early for a profit, then ride the stock price back up again.
It’s quite common to make (say) 2/3 or 3/4 of the maximum possible profit in under half the time.
This is a smaller profit in absolute terms, but excellent as an annualized rate.
And keeps you off the street doing other trading mischief.

(4)
Even more obscure.
It’s getting towards the end of the term.
The stock price is strong; higher than $340. You didn’t close it early for a profit.
The call you’ve written, seen in isolation, is in a pretty big mark-to-market loss position.
(you’ve made an offsetting and larger profit on the stock that’s paired with it, but the call itself is running at a loss)
Often you’ll see this opportunity:
Late in the year, close the January 2023 call for a loss, and write a June 2023 call (6 months later) at a higher strike that is now at the money.
This will increase the net exit price of the shares you “sold” now by adding the call,
and frequently you can do this in a way that the transaction also raises cash the day you do it.
Higher breakeven, more cash–not so bad.
This works as well as it does in part because at-the-money options have higher time value than in-the-money options.
You sold one pretty much at the money, but when you’re closing it it’s now in the money.
Plus, of course, the evaporation of time value works in your favour.
This is a fancy way of improving the outcome of situation (1)&(2) above: a “redo” with a higher exit price or more cash, though it takes longer.

Jim

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Ok, writing covered calls is not the same as selling stock.
Nevertheless: What happened to Jim’s 3% rule which says

“If Berkshire is in an upward trend it might continue longer than you think => Wait instead of being hasty”

Jim,

What if Berkshire is in the process of deploying a significant amount of cash? Say $60 Billion or so. Maybe to buy a certain oil company with significant oil and gas reserves in very safe places. Would your perception of BRK’s value increase at all?

Could we be headed to a higher and more permanent P/B plateau? In other words (gulp), could this time be different?

Thanks as always for your insights.

BHH

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<<January 2023 $340 calls are trading at $29.>>

I can’t find that price on Yahoo financial: https://finance.yahoo.com/quote/BRK-B/options?p=BRK-B

Could you show where to get it? Thanks.

I found out there is an option for 1/20/2023 in the dropdown option. Thanks.

I did things the old fashioned way - I sold some shares (@ $341). The main reason is that I want the cash available for other ideas.

I sold about 5% of my BRK - although I was tempted to sell even more. This is equivilant to the amount I purchased back in October (@ $288)

tecmo
…

2 Likes

What is going on???

Berkshire does not rise 2.1% (the current state the moment I write) in a single day. It simply doesn’t do that. So: Why?

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Jim,

Thanks for the info. I just sold 1 option at $30, the first time ever of option trading. This fits my situation very well as I plan to sell more BRK-B shares, now I will use options, it seems a nice protection in either way.

This is a fancy way of improving the outcome of situation (1)&(2) above: a “redo” with a higher exit price or more cash, though it takes longer.

I tend to write my covered calls for much shorter expirations (a month or two). Just so that I have more to do to keep me off the streets. When necessary, I typically roll out another month to the highest strike with little to no net debit.

In theory the stock price could rise farther and farther away from my strikes. But I wonder if BRK has ever done that over a period of a year or more. Without looking at the actual price history I speculate that the stock price always takes a breather to eventually allow closing the calls without a loss.

Ok, writing covered calls is not the same as selling stock.

Opening a covered call position (buying stock and writing a call) is not the same as selling stock.
But that’s not the suggestion here.

Writing a call to accompany a pre-existing long position is equivalent to selling that stock…albeit conditionally.
You just don’t know for a while whether you sold the stock or merely pocketed some cash.

Nevertheless: What happened to Jim’s 3% rule which says …

Some people like to play the odds of what a stock price might do next. Stack the deck a bit.
If you are comfortable with that notion, then by all means wait for a bit of a pull back.

But selling at a good solid multiple has its own logic and merits, depending on your situation, even
if you’re not the type to try to play the odds on short term price movements.
Market pricing instead of market timing, as it were.

Given the fresh new highs, it seems likely that in the very short term, more of the same is somewhat more likely than not.
But some people quite reasonably don’t care what’s slightly likely to happen next. The price on offer is a more knowable thing.

Jim

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<<January 2023 $340 calls are trading at $29.>>
…
I can’t find that price on Yahoo financial: https://finance.yahoo.com/quote/BRK-B/options?p=BRK-B
Could you show where to get it? Thanks.

In the pull-down box for the dates, select “January 20, 2023”.
The top section of the table is call options.
Scroll down that top section till you see the strike price of $340.
At the moment, that’s the last blue row.

Then look across and you’ll see columns for the last trade price, bid, and ask.
Ignore the last trade price. (always).
You could sell at the bid, or most likely a bit better using a limit order.
At the moment, the bid is shown as $30.65.
Selling one of those is equivalent to (conditionally) selling some of your stock at $370.65/B = $555975 per A share.

You’re giving the counterparty the right to buy from you at (net) that price any time till next January.
It’s extremely unlikely they will do so as long as the option has any time value left.

Jim

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Maybe to buy a certain oil company with significant oil and gas reserves in very safe places. Would your perception of BRK’s value increase at all?

Sure, but realistically, in (say) any given stretch the value doesn’t usually go up more than a certain amount.
In a year, maybe 10-12% tops, normally, so ten months till option expiration is almost certainly less than 10%.
(well, say inflation + 8%, give or take)
The visible value frequently changes more than that, but that’s usually more due to transient price changes in the portfolio or unusual underwriting results.
Even a fantastic year isn’t likely to increase the true lasting value per share more than 12% these days.

The most likely way value could rise a lot in a year is if the stock market plummets for a good long while.
Good for Berkshire to go shopping, and also good for buybacks.
In that case, you close the calls for a sweet profit during the low price stretch.
Equivalent to to selling high then buying back low.

Jim

6 Likes

<<In the pull-down box for the dates, select “January 20, 2023”.
…>>

Thanks again for your help. I didn’t trade options before as I thought “there is no free lunch” so there must be a downside. However this trade has no downside to me as long as the stock price is above 310 as I want to sell the shares anyway.

I tend to write my covered calls for much shorter expirations (a month or two).

I usually go for two quarters out, 4-5-6 months.
Enough money to make it meaningful.
But if it doesn’t work (stock price rises meaningfully), I can roll up and out another 6 months, as in outcome (4) in the kickoff post.

The date I mentioned, next January, is longer than I’d usually do.
But $30 per B share is pretty good money.

Jim

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However this trade has no downside to me as long as the stock price is above 310 as I want to sell the shares anyway.

The best way to think of it is like this:
Ensure you’re really happy with the two main outcomes. Selling the stock, or keeping the cash. Ideally, equally happy.
Because, sure as shootin’, you’ll end up with the alternative that seems worse at the end date.

i.e., the downside is that you wanted to sell anyway, and you don’t end up selling, just pocketing some cash.
That will happen if the stock price is low, so you won’t want to sell then. You’ll have to wait a while longer.
Not a terrible downside, but it’s something to remember.

Jim

4 Likes

"What is going on???

Berkshire does not rise 2.1% (the current state the moment I write) in a single day. It simply doesn’t do that. So: Why?"


Possibly something big only the insiders know?

as Bob Dylan says… “The Answer My Friend Is Blowin’ In The Wind”

ciao

Sold 1.5% of my Berkshire…not much…but my selling virtually guarantees the price will go up! haha

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Squint & the last 2+ yrs take you back to the 90’s.

https://stockcharts.com/h-sc/ui?s=BRK%2FA&p=W&st=199…

or you can go back to the 70’s & watch the large lime green lava lamp bubble rise to the top of the financials…

https://www.chartfleau.com/bubblechart

ciao

Jim,

Thank you so much for sharing the strategies you use with options.
Its something I am starting to use to juice a little more my portfolio and I am learning and experimenting with all this ideas.

One more time thanks for sharing your knowledge !!!

5 Likes

Today’s PBV is 1.506.

In last 10 years, BRK has been above today’s PBV only 5% of the time.

It would be interesting to see the co-relation between inflation rate and BRK’s PBV

1 Like