Adam Warner reports on a transaction in which Warren Buffett sold naked puts in 2007, betting that world markets would be higher in 15 to 20 years.
Buffett Put Watch?
Courtesy of Adam Warner at Daily Options Report
So guess who beat the rush to do some naked put shorting?
And I mean really beat the rush, like 2007 and mid teens VIX "beat".
This, from Jon Markman.
Shares of Warren Buffet’s insurance holding company are on the ropes this month, plunging 30% in part because the fabled investor dabbled in an area of the market he has long publicly derided: derivatives. And due to a tangled web of financial relationships, they may be taking Goldman Sachs shares down with them.
Investors are concerned about a $37-billion bet that Buffett made last year that U.S. and world equity values would be higher in 15 to 20 years than they were then, when the Dow Jones Industrials were trading around 13,000. Through his firm, Berkshire Hathaway, Buffett sold option contracts, known as "naked puts" to an undisclosed group of investors for around $4.85 billion, reportedly using Goldman as broker.
The buyers saw the puts as a type of insurance that would pay off royally if stocks fell over the next decade. They were seen by Buffett as an easy way to pocket a quick $4 billion-plus, which was booked much like an insurance premium, even though he is famous for scoffing at derivatives as "weapons of mass financial destruction."
As Jon notes, there are rumors that part of The Oracle’s "investment" in GS was de facto collateral on the trade.* Becky has no comment.
How bad is the trade?
Without knowing exactly when he put it on, what volatility he got, the exact length, et. al., it’s a little rough. Jon had some numbers. And there’s huge margin of error going out that far in time, as among other things, what volatility do you use?
So throwing all those disclaimers into the hopper, best guess was that these puts may have tripled in value against Buffett. And that’s possibly conservative as I pretty much took the lows of 2007 as his starting price, and didn’t run a particularly high volatility out a decade.
Now granted, $8 billion for Berkshire is not the end of the world. And in a sense it’s not fair to just look at one transaction, as it surely fit into a larger plan.
But still, ouch. Not going to be seeing quite the same tips at the Omaha Hooters going forward.
*****
*Note: According to Jon Markman, "because of its solid-gold credit rating, Berkshire Hathaway was not required to put up collateral to make this trade. But now rumors are flying on Wall Street that the owners of the contracts have demanded that broker Goldman Sachs put up collateral for the rest of the amount due. Since the value of the trade could be enormous, the collateral demands are said to be very large, and fears that Goldman will struggle to make good on its obligation has panicked shareholders." – Ilene
Source: Buffett’s huge derivatives bet proves costly, by Jon Markman.
