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Confession time- I closed out my June 2024 405 covered call contracts written in early Feb. Took a small net loss, but feel better with less BRK shares potentially being called away if there is a run-up in price around the annual meeting & subsequent weeks. Jim gave me very fair warning- the less favorable option to the writer often finds its way as the ultimate outcome.

There were more warnings: When you sold them early Feb BRK was probably around $390, so the $405 calls strike was just a tiny $15 = 3% above the then current price. I am not sure which posters warned against doing so, but definitely Maxthetrade did, and Bluehorseshoe (or somebody else?) even said he always calculates with a short-term run up of 10% and therefore sells BRK covered calls only with a +20% margin.

Greedy I myself violated this by selling on 29.Jan when BRK was at $385 calls with strike $420 = 9% margin --- but luckily after a small exchange with Maxthetrade heeded his warning, immediately bought them back and sold $430's instead. Even with that 12% margin the following time was very scary for me when BRK didn't stop going higher and higher.

So we both should learn our lesson and heed the warnings of those experienced guys, which for me is: Selling covered calls when I think BRK is close to the top of it's range: Yes! But: Ideally with a strike 20% above current price. If greedy: Only 15% above. But any lower than that: Potential suicide (at least if one loves his Berkshire shares).

Given that covered calls on BRK has come up, the following may be of interest:

https://static1.squarespace.com/static/641cca1972c...

To be clear, I have zero association with Check Capital Management (or any other firm). Also, we're all capable of debating the fine points of selling covered calls, versus selling cash secured puts, versus holding BRK long, versus buying DITM calls when BRK is under-valued (my preference!), etc.

I simply found it interesting to have come across real world data on systematically selling covered calls on BRK, dating back to 2011.
~

I happened to come across a research by Goldman recently, about various “option enhanced” strategies. Essentially, selling calls will lower your portfolio volatility AND returns. And it’s on average losing money if done earning events. The ones that make money on average are selling puts when stock tanks and buying calls before earnings, but only for less than 10% of stocks in the portfolio

Selling covered calls when I think BRK is close to the top of it's range: Yes! But: Ideally with a strike 20% above current price. If greedy: Only 15% above.


Ah, hmmm.

I sold the Jun 425 when BRK-B was 417.55. That was only 1.8% above. Yikes.

The conventional suggestion for covered calls is next strike up, next month out.
That was 1 strike up but 4 months out. Bad move!

I have been thinking about buying it back, even though at a loss, but didn't have enough spare cash in the account.

selling calls will lower your portfolio volatility AND returns.

Is this a misunderstanding? We are talking about covered calls, to make some extra $. Why should selling Berkshire covered calls lower returns - if done conservatively, with a strike price high enough so that there is very low probability of the shares being called away?

If I am not completely mistaken there are several posters here who say they use this strategy since 10 or 20 years to constantly(!) add 2% or so to the returns of their Berkshire shares ( without ever or only once the shares having been called away).

I happened to come across a research by Goldman recently, about various “option enhanced” strategies. Essentially, selling calls will lower your portfolio volatility AND returns.

Though I don't argue with their research, bear in mind that they are presumably not trying to take into account what the underlying asset is actually worth. They are presumably testing the strategy of writing calls all the time, through thick and thin.

Presumably writing calls on things that are temporarily highly valued is on average a profitable strategy, just as writing calls against an asset which is temporarily undervalued is on average a losing strategy.

As for the recent relatively high valuation multiples for Berkshire, I think the calls I have written (and those of others) may have been a rational choice even if they are not profitable at the moment, including those written right at the money. That's because I think that statistically the odds favour the stock price being slightly lower, not higher, than current levels later in the year. The fat lady has not yet sung.

If observable value per share rises at the usual rate in the next year, and inflation is maybe ~1%/quarter, and valuation multiples recede back to their ~10 year averages, then today's nominal stock price is maybe about what you'd expect first quarter next year. We have been pre-paid for this year's value growth : )

All that being said, a statistical strategy can have a positive expected outcome but still fail! The price is higher now than seemed probable a few months ago, so the calls I've written are not in aggregate profitable at the moment, and it's possible that won't change. However, I did them with the understanding that they might go wrong, and I'd be pretty happy with the above-average net exit prices of the stock that gets called away, being much higher than the prevailing stock price at the time. There's always another "buying opportunity" bus coming along.

Jim

"selling calls will lower your portfolio volatility AND returns."

Is this a misunderstanding? We are talking about covered calls, to make some extra $. Why should selling Berkshire covered calls lower returns - if done conservatively, with a strike price high enough so that there is very low probability of the shares being called away?

There are 4 price quadrants: up/down & a little/a lot.

Both littles are a wash.

In up a lot, your gain is capped, you miss out on all the gain past the strike.

In down a lot, you fully participate in the loss. This is infrequent, but gives you a large loss.

If you continually write covered calls then the law of large numbers says you will sometimes hit the down a lot quadrant.

In order to win at covered calls you have to have a strategy to avoid the down a lot times. And preferably also don't write CCs in the up a lot times.


who say they use this strategy since 10 or 20 years to constantly(!) add 2% or so to the returns of their Berkshire shares ( without ever or only once the shares having been called away).

Not possible. Not possible if done constantly. In the "up a lot" quadrant the stock will get called away.
BWDIK?


For example, suppose your strategy is to sell a CC at 5% above the current price.
BRK-A monthly returns from 1980 to 2024, 528 months:
For the "a lot" quadrant:
126 (23.9% of months) were gain of more than 5% (Average such gain: 10.05%)
51 (9.7% of months) were loss of more than 5% (Average such loss: -8.97%)

For the "a little" quadrant:
196 were gain less than 5% (avg gain: 2.17%)
155 were loss less than 5% (avg loss: -2.22%)

The "a littles" are a wash, so the total gain here is just the option premium.
Up a lot you get stock gain of 5% but miss out on an additional 10% gain.
Down a lot you get stock loss of -5% and the additional loss of -9% (net -14%).
Both mitigated by the option premium.

Assuming I got the math right.

======================================
How far up do you want to go with the strike so there is little chance of it being called away?
10% above current price there were 45 months. 8.5% of months. You'd be getting the 10% return but missing out on an additional 14.9%. Yuck!

BRK-B is currently 400. The next month (May 17'24) 440 call is bid 0.24 ask 0.32.
Probably you could sell the call for 0.28. That's a whole $28 premium! Why bother?

Try 5% OTM, that's the 420 call. Selling 1 call will net you $200 premium.


Who knows, maybe there is something I'm missing?

There are 4 price quadrants: up/down & a little/a lot.
Both littles are a wash.
In up a lot, your gain is capped, you miss out on all the gain past the strike.
In down a lot, you fully participate in the loss. This is infrequent, but gives you a large loss.
If you continually write covered calls then the law of large numbers says you will sometimes hit the down a lot quadrant.
In order to win at covered calls you have to have a strategy to avoid the down a lot times. And preferably also don't write CCs in the up a lot times

The four cases are clear, though I think of it slightly differently: by comparing covered calls to a long stock portfolio with the same equities. You're better off with covered calls versus plain stock in three of the four cases: the price is up a little, down a little, or down a lot during your option interval. (you lose in that interval if the stock is down a lot, but you lose less than you would have with plain stock) Only in the "up a lot" quadrant would you have been better off with plain stock rather than covered calls.

But...few stocks go "up a lot" every quarter. It's a pretty infrequent thing, for most stocks. So, though a covered call might well do worse than plain stock in any given time interval, the odds of a covered call strategy doing better than a long stock strategy with the same underlying are reasonably good when repeated over time. That's assuming this is done with a bit of prudence...not writing calls when a stock is cheap and arguably due for a big jump. Not writing calls when the VIX is under 12 meaning selling any kind of option is probably not remunerative enough to be worth bothering. And picking an appropriate underlying stock that isn't wildly unpredictable or wildly hard to value.

It's also best in a tax sheltered account, as you'll sometimes lose your stock and have to buy it back. You don't want to *avoid* the stock being called away: it's not a bad thing. That means you're picking strikes that are too high to be worth bothering with.

Jim

maybe there is something I'm missing?

Yes, one of them a fact you simply can't know. Me (and at least Max) are in a special tax situation which causes that it would hit us MUCH harder than any non German (and as most of them too) if our Berkshire shares would be called away (have written that repeatedly --- but you are not obliged to read my often white noise only, with little substance posts :-)

So we can only write covered calls with an extremely(!) high probability for them not to be called away. Which is why he recommends strike >=20% above current price (with me as gambler lowering that to >=15%).

Now you could present me with the statistics in how many months BRK did move more than 20% (or my 15%). But that misses one critical point, the point Jim just explained: We sell covered calls not randomly. We only do that if BRK is richly valued. For me this means: Selling covered calls only(!) when Price to Book Value is 1.5 or higher! And then calls not 1 month out (premium would be just a few cents), but calls at 1/2 - 1 year out.

If you can without too much work provide numbers how often BRK moved 20% (or 15%) higher during say the next 1/2 year and 1 year from such a valuation, I would be very grateful, as that's the appropriate test to apply.

In down a lot, you fully participate in the loss. This is infrequent, but gives you a large loss.

We are talking about the strategy of LTBH Berkshire shareholders to make a few extra bucks, people who hold Berkshire through thick and thin and wouldn't sell in this case anyway, whether they wrote covered calls or not.

you lose in that interval if the stock is down a lot, but you lose less than you would have with plain stock)

Yes. You always get to keep the premium. The problem I have is that most CC proponents double count the premium. They say "boost your returns by 2%-4%" (which means you spend/keep the premium) AND "the premium reduces your loss" (which means you don't keep/spend the premium).

Typical comment in a CC article: "By choosing the right stocks and options, you can generate consistent monthly returns of 2% to 4% per month."
"...generate passive income from your investment portfolio"
This article is titled: "How to Create 2% to 4% Monthly Returns with Covered Calls."

If you take the premium as income, you can't also use it to reduce the loss.


But...few stocks go "up a lot" every quarter. It's a pretty infrequent thing, for most stocks.

Doesn't seem to be the case for BRK.
Assuming that Yahoo historical quotes are right for BRK-A, 24% of months had a gain more that 5%.
PORTFOLIO VISUALIZER data shows 104 of 467 month (May'85 thru Mar'24) had return more than 5%. That's 22.2% of months. The average return above 5% was 9.75%.

For rolling quarters, 198 of 464 rolling quarters gained more than 5%. The average return above 5% was 13.77%.

What kind of premium are we looking at?
Looking at BRK-B at 396.92, what do you sell? The May 410? At 3.70.
If it goes out at 397, your position makes (397/(396.72 - 3.70)) = 1.0127%
For one month. Not bad, not bad at all.

OTOH, if you take the premium and spend it, you get (3.70/396.72) = 0.9326% monthly yield.

Not 2%-4%, but still.....

=========================
Now I'm curious about some other stocks. From google: "Similar to Apple, some other stocks that are good for trading covered calls include Microsoft, Meta, and Amazon."

{Damn, why didn't I buy MSFT in 1986? $10,000 grew to $71,053,756}
MSFT, 154 of 457 (33.8%) months were more than 5%.

AAPL, 195 of 469 months were more than 5%.

I'm going to cry.
I hope I did something stupidly wrong, but it seems straightforward. Download monthly returns. Sort. Boom. Count the number of months with greater than 5% return.

Now you could present me with the statistics in how many months BRK did move more than 20% (or my 15%) ... For me this means: Selling covered calls only(!) when Price to Book Value is 1.5 or higher!


Darn, I closed my spreadsheet without saving it, so I have to do it all over again. No biggie.

For all rolling 6 month periods, 32.5% of them BRK gained more than 15%.
23.7% of them BRK gained more than 20%

For all rolling 12 month periods, 49.0% of them BRK gained more than 15%.
41.1% of them BRK gained more than 20%

Monthly, only 3.0% of months gained more than 15%. And 1.7% more than 20%.
The most recent was Feb 2000 which gained 30.0%. But Jan 2000 lost -14%. In the 4 months before Feb'00 BRK lost -23%. In fact, 9 of the preceding 12 months had a loss.



I do not have historical P/B numbers. If anybody has that data and can email it to me, then I could incorporate into the spreadsheet (which I did save this time).


"In down a lot, you fully participate in the loss. This is infrequent, but gives you a large loss."
We are talking about the strategy of LTBH Berkshire shareholders to make a few extra bucks, people who hold Berkshire through thick and thin and wouldn't sell in this case anyway, whether they wrote covered calls or not.

Now you are mixing two different things. Either you recognize the loss or you close your eyes and ignore the loss. The loss is there whether or not you chose it recognize it.

The point is that you chop off the gains at the strike, thus missing out on the gains above the strike, but you fully participate in the losses.
Yes, you always keep the premium.

I do not have historical P/B numbers. If anybody has that data...
Here it comes:

BRK - Quarterly Book Value since 2000
BV Q1 Q2 Q3 Q4 BV YTY Year End Price

2000 $38,023 $37,011 $37,810 $38,938 - $71,000
2001 $40,436 $38,240 $38,464 $37,475 -3.9% $75,600
2002 $37,854 $39,444 $40,819 $41,718 10.2% $72,750
2003 $52,575 $45,995 $46,870 $50,484 17.4% $84,250
2004 $55,806 $52,302 $52,455 $55,806 9.5% $87,900
2005 $56,160 $57,213 $58,125 $59,372 6.0% $88,620
2006 $61,878 $62,857 $66,282 $70,277 15.5% $109,990
2007 $71,210 $74,484 $77,475 $78,001 9.9% $141,600
2008 $77,075 $76,176 $77,555 $70,330 -10.9% $96,600
2009 $66,208 $73,812 $81,282 $82,052 14.3% $99,200
2010 $89,378 $86,650 $90,836 $95,433 14.0% $120,450
2011 $97,073 $98,709 $96,901 $99,837 4.4% $114,755
2012 $106,613 $107,356 $111,695 $114,196 12.6% $134,060
2013 $120,520 $122,873 $126,763 $134,986 15.4% $177,900
2014 $138,454 $142,483 $144,580 $146,226 7.7% $226,000
2015 $146,979 $149,743 $151,097 $155,495 6.0% $197,800
2016 $157,350 $160,012 $163,813 $171,565 9.4% $244,121
2017 $178,082 $182,843 $187,450 $211,718 19.0% $297,600
2018 $211,000 $217,654 $228,772 $212,500 0.4% $306,000
2019 $224,950 $233,997 $243,606 $261,417 18.7% $339,590
2020 $229,293 $245,765 $264,323 $287,031 8.9% $347,815
2021 $293,636 $311,276 $316,443 $342,622 16.2% $450,662
2022 $345,469 $314,090 $310,652 $467,000

9.6%
Average

Mhm, I was too fast. It's only quarterly, sorry. I don't have monthly data. Do you think interpolating the missing two months would be too much "cheating"?

(As it wouldn't capture events where the price did rise a lot and fell again in between those quarters.)

Me (and at least Max) are in a special tax situation which causes that it would hit us MUCH harder than any non German (and as most of them too) if our Berkshire shares would be called away (have written that repeatedly --- but you are not obliged to read my often white noise only, with little substance posts :-)
So we can only write covered calls with an extremely(!) high probability for them not to be called away.


Offhand, my suggestion would be that writing covered calls isn't really a good choice for you. It's in their very nature that sometimes a position will get called away. I imagine there are other ways to generate a little bit of income or price improvement that might work better in your situation.

Jim

But...few stocks go "up a lot" every quarter. It's a pretty infrequent thing, for most stocks.
...
Doesn't seem to be the case for BRK.
Assuming that Yahoo historical quotes are right for BRK-A, 24% of months had a gain more that 5%.
PORTFOLIO VISUALIZER data shows 104 of 467 month (May'85 thru Mar'24) had return more than 5%. That's 22.2% of months.

I wouldn't count a 5% move as "up a lot". The weighted average premium for the calls I have currently is 7.6% of the strike, and they were all somewhat out of the money when written. In absolute terms, the premiums were about $25-$31. The round before was a little less, closer to $20.

As discussed in other posts, the question isn't the likelihood of "up a lot", it's the likelihood of "up a lot starting from a high valuation level". And even then, your bad outcome is "selling some stock at a price higher than an already high starting valuation level, but not as high as where the stock happened to be trading at expiry". That's not exactly a disaster scenario.

So, your outcomes are:
* Down a lot, you keep the premium, bad on a mark-to-market basis but better of than if you'd stuck with plain stock
* Down a little, you keep the premium, better of than if you'd stuck with plain stock
* Up a little (but not above strike), you keep the premium, better of than if you'd stuck with plain stock
* Up a little (above strike, but not above strike+premium), stock called away if you wait till the end, though you could immediately buy it back. You keep part of the premium, better of than if you'd stuck with plain stock
* Up a lot (above strike+premium), the case discussed above. You got an exit price maybe 10+% above a high starting valuation level, so you did well, but worse off than if you hadn't done the deal AND had sold at the high price at the expiry date. You might be able to buy back in at a lower price, possibly not.

The key is that these rosy views only work if you never write a call unless the stock seems richly valued to start with.

Jim

* Up a lot (above strike+premium), the case discussed above. You got an exit price maybe 10+% above a high starting valuation level, so you did well, but worse off than if you hadn't done the deal AND had sold at the high price at the expiry date. You might be able to buy back in at a lower price, possibly not.


One aspect of BRK covered calls that hasn't been mentioned: if your shares are about to be called away (and you wrote the calls when the valuation was high) then the current valuation is very likely even higher. So buy back the call (at a loss) and write another. Eventually, the call will expire worthless.

Profitability of options is a probabilistic question. Strictly avoiding your call being in-the-money at expiration isn't necessarily the most profitable strategy.

The key is that these rosy views only work if you never write a call unless the stock seems richly valued to start with.

Which brings us back to a thing that was said a while ago.
*) When BRK is "low valued" (e.g., P/B ~1.35) put on leverage (buy DITM call)
*) When BRK is "richly valued" (e.g., P/B ~1.55) take off leverage and possible go to negative leverage (sell covered call)

But that's not writing covered calls for income (2%-4% a month). That's more like card counting at Blackjack--go big when the odds are in your favor.

You don't have to make money in both bull and bear markets. It's good enough to just make money in bulls and not lose too much in bears.

Seems to me that the thinking behind the "CC's for income" crowd is somewhat similar to the thinking of the "invest for dividends" crowd. There are better ways to accomplish the goal of getting periodic cash.

Plus there's some magical thinking going on here. 2-4% a month is 24%-48% a year. There is NO POSSIBLE WAY that the big players in the market are ignorant of a strategy that consistently makes 24%+ a year, let alone a simple strategy that makes that much.

That work I did in examining monthly returns was an entertaining intellectual exercise. It was fun, and gave me something to do beside watching Youtube videos for a couple of days. Also convinced me to stay completely away from trying to make money by messing with short calls and puts. Too complicated for me.

I had NO IDEA that large monthly moves were so common. 8.5% of months had gain more than 10%? Average gains of those months was (10% + 14.9%)? Astonishing.

I did know, from Meb Faber, that large up months and large down months often happen together. A couple of cases with BRK-A: -14.33%, +16.18%, -10.33%. And -14.06%, +30.00%. And -13.73%, +10.45% -- that was the last >10% month, on July 2022.

Said:
Me (and at least Max) are in a special tax situation which causes that it would hit us MUCH harder than any non German (and as most of them too) if our Berkshire shares would be called away (have written that repeatedly --- but you are not obliged to read my often white noise only, with little substance posts :-)
So we can only write covered calls with an extremely(!) high probability for them not to be called away.

Mungofitch:
Offhand, my suggestion would be that writing covered calls isn't really a good choice for you. It's in their very nature that sometimes a position will get called away. I imagine there are other ways to generate a little bit of income or price improvement that might work better in your situation.

Why wouldn't you just buy the calls back to close the position at say 15 minutes before market close when options are in the money?

If you have written the calls you are at the mercy of the purchaser. They can and will get called early.

I wrote Jan'25 calls with a strike price of $430. That was on 29.Jan when BRK-B was at $385. The price of the calls were $8.15 then, so I received $815 per covered call contract I wrote, a bit more than 2% of the value of the underlying assets (100 shares of Berkshire stock).

Though the strike price of $385 I chose was $45 or 12% higher than the then current price of $385 it was not high enough to be on the safe side: In the following 3 weeks the price of BRK-B rose in a straight line to $430, the high on 26.Feb, so they were just in the money then. The price of my calls also did rise accordingly, if I remember correctly to around $24 or so, triple of what I received for writing them.

You are right, I could have bought them back on at that day of very high risk that if BRK-B rises further in the following days they might be called away. Had I done that (which I luckily did not do because I was unaware how high it did rise on 26.Feb) I would have booked a loss of $24 (price to buy them back) - $8.15 (premium received) = $15.85 per call respectively $158.5 per contract, a bit more than 4% of the value of all Berkshire shares behind those covered calls, realising double the loss (4%) of the intended profit (2%), a huge double whammy.

Max warned me before to chose a strike below +20%, saying it can be extremely expensive to buy the calls back when Berkshire rises so much that the danger is high that they are called away. He was right --- and I was sweating during those days (still not completely over).

I think that is unlikely because by exercising the call, the holder of the long call is sacrificing all the time value. It would make more sense to sell the call the someone else, and capture the time value.

"If you have written the calls you are at the mercy of the purchaser. They can and will get called early."

But only very rarely, and only by complete option novices. Basically, someone who does this likes to give away free money.

Look at any random option in the money. Let's say the BRKB 405s expiring tomorrow. Someone (a novice) might choose to exercise the option right now and buy it for 405 with the shares trading at 406.10, they would get the shares for a net discount of 1.10. But why on earth would they do such a thing when instead they could simply sell the option for somewhere between $1.191 and $2.03 (current bid and ask). Heck, even if they want a quick fire sale, like instant execution, and they sell for $1.50, they would still extract more value from that option than by exercising it. But this is true for ALL options in the money, even with 1 day left, there is always a small bit of time premium in the option.

tadthedog wrote:
Given that covered calls on BRK has come up, the following may be of interest:

https://static1.squarespace.com/static/641cca1972c...

The link flogs a service "Berkshire Covered Calls Program" which returns a pretty smooth 8.1%/year from 1/1/2011 through 12/31/2023.

The brochure compares this to a bond fund returning a fraction of this... see? Its better!

What the link doesn't discuss is just putting your money in BRK as an alternative. I checked that and during the same interval, BRK stock returned 12.6% / year.

Or put another way, over that interval BRK 4.7X your money while this fund 2.7X your money.

So for the life of me it looks like the covered call program did what you would expect:
1) shaved off returns when the stock was rising fast
2) filled in returns when the stock was falling or flat

With the net being a SMOOTHER curve at the cost of NET SLOPE (or NET RETURN).

Considering this smoother slope cost you 4.5% on your average return. It would be like paying a manager 4.5% to smooth your return for you. Yikes! Why?

R:

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