Which BRK Puts to buy as a hedge?

I am extremely overweight Berkshire (actually everything else I own pales in comparison) — and therefore extremely dependent on it. The rise of Berkshire’s share price is a bit too steep and too much for me to believe it to be sustainable and if I could I would sell a GOOD portion (20% or so) of my shares right now, but for tax reasons explained before I can’t sell BRK shares (nor covered calls with the risk of the underlying shares eventually to be called).

As super complicated option strategies are too difficult for my poor layman’s brain to comprehend I see only one option to hedge against my expectation of Berkshire’s valuation soon becoming more in line with it’s past (and therefore to fall 10%-15% or — if the crash prophets are soon vindicated and the whole market goes down — even more): Buying Puts. May I ask the option specialists here which ones they would recommend?

(Usually I am buying only the furthest out LEAP’s, currently Jan’24. But as I expect Berkshire’s current price not to last that long I am thinking on something like Jan’23, currently around $16.)

Oops. As always hit “Submit” too fast, sorry. I meant the Jan’23 ones with strike $300, currently around $16.

Buying Puts. May I ask the option specialists here which ones they would recommend?

One thought: Don’t bother.

If you think troubled times are coming, only cash is cash.
For most folks, you don’t have to sell a whole lot to have enough cash cushion to give you quite a few more options if things get interesting.

And as for the tax hit of selling—remember, selling gets a tax hit, but your hit isn’t the tax, only the time value of the tax.
For most folks, the tax is going to get paid sooner or later anyway.
Sometimes–occasionally–paying a bit more tax is OK.

If you really want to take the opportunity to make some money on any upcoming market fall,
don’t buy puts against Berkshire, buy puts against a few firms likely to lose their antigravity shoes.
A bit here and there against, say, the worst of the SPACs and the third tier bandwagon EV firms?

Jim

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Jim, thanks for the advice. Re the tax let me clarify:

your hit isn’t the tax, only the time value of the tax.For most folks, the tax is going to get paid sooner or later anyway.

Me as well as Max and a few other German residents are exceptions from those “most folks” insofar as we have shares bought before 2008 which we can sell anytime completely tax-free, even in 10, 20 or 30 years (as long as the law isn’t changed retroactively which the German constitution forbids). That makes holding onto those shares immensely more valuable.

Me as well as Max and a few other German residents are exceptions from those “most folks” insofar as we have shares bought before 2008 which we can sell anytime completely tax-free, even in 10, 20 or 30 years (as long as the law isn’t changed retroactively which the German constitution forbids). That makes holding onto those shares immensely more valuable.

“I have shares. The more I hold them the more tax savings I get compared to any shares I buy now. And yet, I think they are overvalued at, say, $300.
Now: I don’t want to sell them at $300 now. I don’t want them to be called away at $300 in six months. But a year from now, if they are down to $200, THEN I want to get $300 from them.”

Yeah, makes perfect sense.

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"I have shares. The more I hold them the more tax savings I get compared to any shares I buy now. And yet, I think they are overvalued at, say, $300.
Now: I don’t want to sell them at $300 now. I don’t want them to be called away at $300 in six months. But a year from now, if they are down to $200, THEN I want to get $300 from them."

Yeah, makes perfect sense.

Not sure if the remark is meant to be sarcastic, but yes, it does make perfect sense.

If BRK is overvalued at $300 (it’s not, but let’s play along), but one has no need to sell, and knows that BRK value rises steadily over time, then one can look forward to it not being overvalued at $300 at some point in the not-too-distant future. So one would not be compelled to sell in that situation. Waiting is fine if you don’t need the money.

But one can also believe that the market is being generous today and might not be as generous in a month or two, in which case BRK could quickly become undervalued (i.e., priced less than $300). This wouldn’t be a disaster, since the loss would be unrealized and there’s no need to sell, so again, it just becomes a waiting game for the stock to recover.

On the other hand, there’s the thought: Why let an opportunity go to waste? Who wouldn’t want to capitalize on the scenario where BRK temporarily falls by a large amount, if it transpired? Having a long put position in this case would be very nice indeed. One could sell the puts for a nice profit, and use the proceeds to buy more BRK at now-undervalued prices, or use the cash for beer and pizza, as it were.

The only real problem with setting up a position like this in advance, not knowing if it will actually be needed, is the pricing question. Puts aren’t cheap. One could easily spend 5% or more of the total position just to buy a meaningful insurance position in puts. So therein lies the difficulty. It’s a poker decision of sorts. At a low enough price, relative to the size of the position and probability of profit everyone would buy puts. At a high enough price, nobody would buy them.

My personal opinion is that the covered call approach is a good one for Berkshire when prices are approaching something like fair value, since the market never seems to get all that excited about the stock. It will mostly likely either pull back, in which case the calls can be covered or rolled for partial profit or expire for full profit, or they can be rolled for partial profit or at least a net credit with an eye to profit at some point in the future. With a big position it’s also possible to roll some calls and let others be exercised to reduce the stake and make sure the covered call action is never a negative in itself.

The “do nothing” approach is a perfectly fine one, too.

Rob

Yes, it was supposed to be sarcastic.
The basic question is, does said2 want to keep his shares because of the tax advantages or does he want the (overvalued) market price for them?
It seemed like he wants to keep them even if overvalued, UNLESS some stranger is getting a worse price. So he won’t sell now, or won’t let them be called away via covered calls.
Buying a put only makes sense if his put premium + tax savings are overwhelmed by Berkshire’s price drop. Which is a very Goldilocks scenario.
Here is a concrete example.
If BRK’B sells for $300 today, said2 buys puts with strike $300 for $20 for whatever date, his tax rate is 20%, his basis was $100 pre-2008, and on the expiration date BRK’B is selling at $250. He can put his shares for $300 and turn around and buy them back for $250. $30 profit (due to the $20 premium)! But also, whenever he sells those ones later, 20% tax on capital gains. So he better sell them for < $400 ($250 + $30/20%) for this trade to make sense. Otherwise he will end up paying more over the total time period.
And of course, this only works if BRK’B actually declines. During the lifetime of the option. By more than $20 at least. Otherwise some or all of that $20 premium is forfeit.

I don’t want to sell them at $300 now. I don’t want them to be called
away at $300 in six months. But a year from now, if they are down to $200,
THEN I want to get $300 from them." Yeah, makes perfect sense.

What about numbers (below rounded for easier readability/understanding) instead of “sweet” words?

Let’s say Berkshire doubles in value and price every 7 years which most here agree is realistic.

Scenario I
At my age I probably will still have them in 21 years = 3x this doubling interval => 8x$300 => $2400. Then I’ll sell them — tax free = $2400 net.

Scenario II
Expecting $200 in a year from now I sell them now for $300. My expectation comes true and in 1 year I buy with those $300 proceeds then 1.5 shares, a full 1/3 lower, for $200 each. 21 (or rather 20 from then on) years later as in Scenario I each of those 1.5 shares is also worth $2400 => $3600.

Great, isn’t it? $3600 instead of the $2400 outcome of just “sitting on them”. 50% more! But wait. With those “new shares” contrary to the old ones I have to pay German tax on the capital gain of $3300 ($3600-1.5x$200). What are the net proceeds when selling them?

IIa) Ideally the currently discounted rate of 25% only on cap gains remains, resulting in $2800 net = 15% more than the $2400 from Scenario I.

IIb) If in 20 years there is no more discount on capital gains and — as it was the case most of the last decades in Germany — they are taxed with the normal top tax rate of currently 42% that would result in $2200 net = 10% less than the $2400 from Scenario I.

Summary: Holding onto my tax-free shares results within a nearly equal interval on both sides (+15%…-10%) in the same outcome as converting them into taxable “new shares” IF I CAN BUY THE LATTER FOR A FULL 1/3 LESS.

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Scenario I
At my age I probably will still have them in 21 years = 3x this doubling interval => 8x$300 => $2400. Then I’ll sell them — tax free = $2400 net.

Scenario II
Expecting $200 in a year from now I sell them now for $300. My expectation comes true and in 1 year I buy with those $300 proceeds then 1.5 shares, a full 1/3 lower, for $200 each. 21 (or rather 20 from then on) years later as in Scenario I each of those 1.5 shares is also worth $2400 => $3600.

Great, isn’t it? $3600 instead of the $2400 outcome of just “sitting on them”. 50% more! But wait. With those “new shares” contrary to the old ones I have to pay German tax on the capital gain of $3300 ($3600-1.5x$200). What are the net proceeds when selling them?

Ok, this certainly makes your dilemma clear. You happen to have circumstances where you have a historical tax exemption on shares you owned before the law changed, and this exemption is even carried forward for future gains. So I would think that selling shares and buying them back is very unlikely to be advantageous, over the long run. And you are particularly fortunate to have Berkshire shares in this situation, because it is a stock holding that most of us think is one of the more predictable winners over the next 20-30 years, both because it is gaining value slightly faster than the index, and because, even now, it is starting at a lower multiple to earnings (calculated in various ways.)

If you think the Berkshire shares have gotten a bit ahead of themselves (this is not my view that I share, but just for the sake of the argument), you might like to sell shares in a different account, or at least get some downside protection, and buying puts might be a way of doing this. In fact, owning shares should have approximately the same return as the combination of owning puts and selling calls, also known as a synthetic short. So one way to obtain the effect of selling shares without actually selling your tax-protected shares would be to set up such a synthetic short. BUT you should be careful not to run afoul of whatever German legislation might prevent you doing this, since this might be deemed to be the equivalent of selling shares. Perhaps having a not quite perfect hedge, like calls at one strike price and puts at another, might get you off this potential hook, but here again, you should get more knowledgeable advice from someone who is familiar with German tax laws before doing that.

Viel Glück, dtb

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I don’t think BRK is overvalued, so I personally wouldn’t buy OTM Puts. If you want to speculate that BRK will trade lower over the next few months (which may very well be the case) I’d either short BRK in a different account or buy deep ITM Puts. For me OTM calls are the way to go at these prices, you can sell them in a different account as well if you have enough cash or other securities to back them up. Choose a strike that is extremely unlikely to get excersised ($400+) and you’ll be fine.
BTW, I also sold some Jan 24 $250 puts for ~$21 not too long ago, not the greatest return but very low risk.

Scenario II
Expecting $200 in a year from now I sell them now for $300. My expectation comes true and in 1 year I buy with those $300 proceeds then 1.5 shares, a full 1/3 lower, for $200 each. 21 (or rather 20 from then on) years later as in Scenario I each of those 1.5 shares is also worth $2400 => $3600.

I wish I was a math guy but there is something I am missing here, I intuitively feel, that makes holding on to your current tax-free shares still the better option.

First of all it’s a Goldilocks scenario, you need BRK to decline by at least your put premium.

Secondly you could buy $200 BRK with new money, not necessarily by putting your $300 shares.

Basically if your cap gain rate is 25% then your effective buy price is not $200 but $200 + lost cap gain savings. So if your basis was $100, and strike price $300, then your $200 shares are actually costing you $250 or maybe $225 or something like that. Basically the more they appreciate before you sell, the more (25%) you lose on tax savings.

Someone help me out here.

“So therein lies the difficulty. It’s a poker decision of sorts.” FoolishRob99

Rob,

I looked at establishing an insured value on my Brk position - perhaps a couple times over the past 20 years. It followed some upward movement in the market where the position seemed more fully valued by the market.

Like you, I concluded that the cost to protect by writing puts was too expensive. In the end, I realized I wasn’t much of a poker player. (That should bring a few “thoughtful” invites from the board.)

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Also, as FoolishRob pointed out, you could just sell the appreciated puts and still hang on to your irreplaceable shares. So that’s the “thirdly”. A straight 0-1 bet where you lose all of your money or profit by (stock price loss - put premium). Given that you are betting in a price decline, it’s the latter, plus the tax savings loss.

you should get more knowledgeable advice from someone who is familiar with German tax laws

I am not interested (any more) on strategies requiring details about tax laws. For example a while ago I had the idea to reduce my extreme Berkshire exposure by changing in my US brokers account from FIFO (First in first out) to LIFO (Last in first out) so that I can sell the 10% or so of my Berkshire shares bought AFTER that tax law changed (those shares do not have said tax advantage). Thanks to Max I had to find out that the German tax authority would not accept that and treats every sale as FIFO.

Consequence for me: Keeping it simple, no complex strategies which might depend on tax laws/interpretations/changes. If I am of the opinion it’s price might have gotten ahead of itself I do the simple thing and buy Put’s with my speculative “Casino/Fun/Play capital” (as I just did yesterday - and against Jim’s really good advice I bought Berkshire puts because I think I can assess that company a little, but definitely have not the slightest idea about SPAC’s, overvalued Tesla copies etc.).

if you want to speculate that BRK will trade lower over the next few months… or buy deep ITM Puts.
Ok, the next ones will be ITM ones. Thanks, Max.

Viel Glück, dtb
Thanks! Very much appreciated.
(Wow! Umlaut (“ü”) with your surely US keyboard?)

Regarding ITM and OTM options: If the motivation clearly is pure speculation, doesn’t then fit OTM options with their higher leverage better the very nature of “speculation” and “bet”? And if one wants to limit the risk that could be done rather by longer out expiry dates?

From all said here now and before I am probably wrong - but why?

Regarding ITM and OTM options: If the motivation clearly is pure speculation, doesn’t then fit OTM options with their higher leverage better the very nature of “speculation” and “bet”? And if one wants to limit the risk that could be done rather by longer out expiry dates?

With OTM options you buy only time value which evaporates unless the stock goes down quickly and you sell. You mentioned the Jan 23 $300 Puts trading @16. To have any intrinsic value at expiration BRK has to trade below $284 which I consider not a good bet and I wouldn’t bet on a steep decline soon either. It may work out but I wouldn’t take that bet considering that Berkshires IV is increasing over time and that the shares aren’t demonstradably overvalued.
If BRK would trade at say 1.8x BV I’d consider buying ITM Puts as well…

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Regarding ITM and OTM options: If the motivation clearly is pure speculation, doesn’t then fit OTM options with their higher leverage better the very nature of “speculation” and “bet”? And if one wants to limit the risk that could be done rather by longer out expiry dates?

max:

With OTM options you buy only time value which …

You are both correct. Another way to think of it, is take an extreme case, Berkshire shares at $325/share, and you could in theory buy severely ITM puts (say at $1000, if they existed) vs way OTM puts at $100.

The $100 (ITM) puts are the right to sell shares at $100, which are obviously worth practically nothing, since there is very little chance that you would want to sell shares at that price; the only possibility is if Berkshire shares were under $100, which we think is unlikely. Buying these puts would be pure speculation, obviously; they would cost pennies, and return amounts hundreds of times higher only under very unlikely circumstances.

The $1000 (OTM) puts are the right to sell shares at $1000; right off the bat, they have an intrinsic value of $675. If Berkshire shares went down to $300, the intrinsic value of your $1000 puts would go up to $700, pretty much completely in line with the change in value of the shares.

So in your case, if you just want to reduce your exposure to Berkshire shares a bit, without selling your shares for tax reasons, the OTM puts are a better hedge. The ITM puts would be speculation, which doesn’t seem to be your motivation.

dtb (we also need ü in French: https://fr.wikipedia.org/wiki/%C3%9C_(lettre)#:~:text=%C3%9C…)

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dtb: if you just want to reduce your exposure to Berkshire shares a bit, without selling your shares for tax reasons, the OTM puts are a better hedge. The ITM puts would be speculation, which doesn’t seem to be your motivation.

The whole thread helped to clarify my motivation for myself, finding that it’s a broad mixture. Yes, I am afraid the market tanks, together with my really big Berkshire ship — but speculation and gambling also is a good part of my motivation. I therefore best stay with my huge Berkshire exposure anyway, independent from tax reasons, as it protects me from gambling with more money than is good for me.

Regarding the market: If the market does not tank I might stay permanently paralyzed on the sidelines with the cash raised. And if it does tank it would be extremely difficult for me to decide when to invest the cash in what as there are no other companies I trust longterm as much as Berkshire.

So it probably will remain as it is: Owning nearly exclusively Berkshire shares + doing a little gambling with options. Thanks to all.

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