No. of Recommendations: 15
Aren't you losing the optionality value of the cash in the case of a market pullback?
Yes. And also "not quite".
Yes, in the sense that the capital I have targeted for a conditional purchase of Berkshire stock is likely to get used for that, rather than for any other opportunity that might arise.
I think of it this way: I have already decided that's what I would do with the money if Berkshire got cheap. It may be a good or bad decision, but that's what I've decided. Given that, I don't mind getting paid up front to *commit* to doing what I've already decided to do. I do have to commit to that possibility, rather than merely planning on it, so in that sense yes I'm losing the optionality of the cash pile. Albeit in return for a payment.
But also "not quite". When there is a market pull back, and put options go into the money, they aren't necessarily exercised right away. As a general rule, if there is any meaningful time value that the holder of the option could realize at the current bid by selling them, that person will sell them rather than exercise them. So a market crash a fair while before expiry won't behave (in my portfolio) at all the same way as a market crash shortly before expiry: if there is still time value, it's very very rare to see an assignment.
Additionally, I could see some of this coming: if I think there *might* be something else I'd rather do with that money, I could buy back my puts at any time. Also, I could buy them back and replace them with longer dated ones which would (as noted above) have more time value and be much less likely to be exercised, if for any reason that looked like a better idea. Long story short, I still have pretty much complete optionality unless and until any specific contract I've written is exercised. "Almost" complete, in that the puts I've written may have a mark-to-market loss I'd have to realize, but that's generally small compared to the pile of cash backing them up.
If I were doing this primarily for the income rather than as a way of getting a good price on Berkshire stock, then I'd probably use a variety of different expiry dates and strikes (and perhaps stocks), substantially reducing the chances of assignment in any given week, which in turn would let me use a bit of leverage. You can write puts with notional value of much more than $100k backed up by a pile of $100k in cash, and almost never need more than 1/3 of the cash for assignments, if the puts are staggered. I did this for years. It pays well but it's a fair bit of work, so mostly I don't do it much any more. My IRR over the years (over 100k contracts) was 10.7%/year based on notional capital committed, but my actual portfolio return was that number times the leverage I used.
Jim
