No. of Recommendations: 5
Because this is the BRK board, let's assume that Jim's underlying for a 'strangle hold' is traditionally undervalued. To simplify the numbers, let's take an example where we scale the current fair value to 100 and the current market price to 90 i.e. undervalued. A 15% off fair value call would be at strike=115 and a 15% off fair value put would be at strike 85.
Given that the market price in this example is at 90, the calls will be farther OTM (27.7% OTM) than the puts (5.5% OTM), so the premia income would be dominated by the put sales (Jim might adjust the strikes, but go with this for the moment):
APPROACH 1:
Given domination by put sales, simplify the strategy to just selling puts and so now the approximated strategy is "half in BRK stock, half in cash while writing BRK puts".
The half that's in BRK stock has a known history.
The half that's in cash/treasuries while writing BRK puts doesn't have a known history.
But writing covered calls on Berkshire does, and at expiration the payoff diagrams of cash-secured puts and covered calls are the same (A detail about this "equivalence" leads to Approach 2 below).
Check Capital Management has a Berkshire covered calls program:
https://static1.squarespace.com/static/641cca1972c...The Check strategy details aren't disclosed, but given that they're a value oriented firm it wouldn't be surprising that they're using their own estimate of BRK fair value to decide strikes for their covered call program.
CAGR of Check Capital's BRK covered call program since 2011 initiation, net of fees, is 8.3%
BRK's CAGR since 2011 is 13%
Take half of each and add: 8.3/2 + 13/2 = 10.65%
Being only half long means the equity ride would be much gentler than being fully invested in BRK. Rebalance as needed, as Jim noted.
CONCLUSION 1:
FWIW, an estimate of the CAGR of something like Jim's strategy, on BRK since 2011, would be somewhere over 10.5% or so, with a smooth ride.
So, a "short strangle hold" could be a reasonable approach.
APPROACH 2:
Although the pay-off diagrams of covered calls and cash secured puts are the same at expiration, Jim noted in a post some time ago that if you're writing covered calls to keep premium then you're a bit bearish, and if writing cash-secured puts to keep premium then you're a bit bullish.
So why not have 50% of portfolio in BRK and 50% in cash as in Approach 1, but write cash secured puts when price is below fair value, and write covered calls when above, and rebalancing as needed. There'd be some difference in CAGR between the covered call side and the cash secured put side, but at first approximation you're half in BRK and the other half doing something like Check (although dynamically switching from writing calls to writing puts depending on fair value)
CONCLUSION 2:
At first approximation, would get something like Check's 8.3% CAGR for half your port, and are long BRK for the other half. So again, 8.3/2 + 13/2 = 10.65% CAGR with a smoother ride. In practice, Approach 2 might turn out better than Approach 1 because you're dynamically shifting from writing calls to writing puts depending on fair value.
This is no longer a short strangle because you're not simultaneously writing puts and calls, but are dynamically shifting between the two option sales depending on price relative to fair value.
It's a "Half long, half right write" strategy.
Usual caveats apply, i.e. I'm probably wrong (didn't sleep well), this isn't necessarily a typical time period, etc. etc.
