No. of Recommendations: 9
$300 in June is possible, but a bit unlikely. If we assume trend book value increase continues then known Q1 bv may be $296 and Q2 should be over $300 as a guess by end of June. We have seen prices at 1x bv but it has been almost as rare as the 1.7x+ that we have seen recently.
I tend to think of it like this. I am quite happy to buy shares when the price is hovering around the median p/b or median p/iv ratio so i will tend to target my all in put sales around that mark based on expiration date. The june contracts you sold for all in at $409 seem to follow that logic as median price based on trend book should be in the $410-$420 range in the March to July timeframe next year.
So what if the price drops lower than that? Value is still increasing at a fairly constant clip as you said and it’s reasonable to think forward returns from purchases around median p/b will track the long term increase of bv and iv of 11-12% (maybe a small haircut for safety). Those feel like acceptable long run returns to me.
I mostly agree with all of this, but I have a different view on 2 points above:
First, while I agree that it is unlikely that Berkshire would trade below book value, if there were a major market correction, that book value would also plunge, as the stock portfolio takes a hit. So 1.2x BV might be less than $300, even if book value is currently $300, if book dropped to $250 for instance.
Second, while I certainly don't lose sleep about having to buy Berkshire at $420, less my $11 put premium, I would like to buy it for $300 even more. Say the share price does plunge to $300, and then my puts are way, way underwater, and I have to buy Berkshire shares at $420, even if they're on sale for $300. You could say that I will still do fine with a cost basis of $420, and I would agree with you, but I would do even better at $300, right? I would say that, come June, this put writing strategy, under those circumstances, would hand me a $120 loss, compared with just not having bought the put. When I try to figure out whether it is worth it to take on this risk, for $11, I have to factor in the small probability of taking this huge loss. Said another way, the maximum upside is always $11, whereas the maximum loss is $409, if the share price falls to zero. The chance of that happening in 9 months is of course minuscule, and even the chance of it going down to, say, $350, is quite low, but not negligeable any more. I won't bore you with the calculations I did to try to estimate those probabilities, but the $11 put premium is borderline, only giving me an expected value of about $1.
Everyone except you and I are probably bored to death with the subject by now, but one last point: If you don't factor in the small probability of a big downside, how on earth can you judge whether the return is adequate or nugatory? (Word of the Day). If the logic you use to justify writing the put is the same logic for any given premium $X, it must be the wrong logic. If you ignore the big downside (the steamroller that caught up to me before I could pick up that nickel), then you would always write puts, no matter what the premium, at a strike price where you are comfortable buying the stock. After all, if you like share price $Y, why not buy write puts that would let you either pocket the premium (if the option expires out of the money) or get the shares for $Y-X? Since it is illogical that writing puts is always a winning strategy, the above rationale is clearly not considering all the possibilities.
