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I was looking at the implied interest rates built into the prices of various Berkshire calls.
They are all high enough now that it's no longer obvious that it's a good investment strategy.

Obviously, it's real rates that matter.
An interest rate of 6% is attractive if monetary inflation is 5%, but not attractive if monetary inflation is 1%.

By "monetary inflation", I mean the fall in the general purpose purchasing power of a US dollar.
If oil prices spike the average Joe might be paying more each month to do what he did the month before, but that's a price change specific to one item.
If you divide all price changes into the components of "what happened in general" plus "what idiosyncratic change happened to t his particular good", inflation is now quite muted.
Basically, if you know nothing else about a company, you should generally expect all their costs and prices and profits to go up by an amount equal to the monetary inflation rate.

The best measure of this I've found is the New York Fed's "Underlying Inflation Gauge", which coincidentally they just discontinued and replaced.
The final figure, released Oct 12 for September prices versus a year prior, was either +2.87% or +2.15%, depending on which of their two calculation methods you preferred.
In short, "general" inflation has collapsed.

But interest rates charged in the market haven't. Not only policy rates, but what the market is charging for "loans" 2-3 years out.
For example, the lowest-strike BRK call for January 2026 has an implied interest rate of 7.60%.
If underlying inflation is and remains in the range indicated by those UIG figures, that's a real interest rate of 4.73% to 5.45%

A higher strike call (but not a super speculative one), for example strike $260, is showing an implied rate of 8.22%.
If underlying inflation is and remains in the range indicated by those UIG figures, that's a real interest rate of 5.35% to 6.07%.

Since I only count on a share of Berkshire rising in value at a real 7%/year on average (though I hope for more), those real interest rates don't look like a great deal, especially as we're likely to see a couple of years of below-trend growth in observable value.
You might end up borrowing at a real 5.5% to see a value increase of a real 6.0%. Not great math.

I have made a lot of money in the last decade with the leverage offered by options, but we always knew the party might come to an end if the interest rates become too substantial.
This might be the moment. Or nearly so.

Jim

I'm busy at the moment or I'd actually look, but maybe this indicates the 'other side' might be attractive i.e. put-selling and covered-calls.
Maybe on BRK, I dunno w/o looking, maybe on other stocks?

I was looking at the implied interest rates built into the prices of various Berkshire calls.
They are all high enough now that it's no longer obvious that it's a good investment strategy.

I have been looking at them too and struggling with the returns not being attractive. MAYBE if we see multiples closer to 1.2x one can squint hard enough to see a mid teens real return. Whether that's attractive enough based on risk is up to each individual.


Jeff

I am confused. I assume you are buying calls. Is the premium you are paying for the call, the same as the implied interest rate? All I know is you get a premium when you sell a call, and pay a premium when you buy one. I don't know what an implied interest rate is.

I don't know what an implied interest rate is.

An implied interest rate is just a way to view the call premium.

Since you can control a share for less money by buying a call versus buying stock, the difference can be viewed as borrowing that amount. To exercise the call will cost more than amount "borrowed". Thus, it is as if you paid interest on an amount borrowed.

In the recent past the implied interest rate hovered around 4% if I recall correctly. Now it is 7% to 8%, based on the higher time value of the calls.

I wonder if the implied rates have jumped up due to the large (and downward) volatility that's happening right now.

I wonder if the implied rates have jumped up due to the large (and downward) volatility that's happening right now.

Maybe a bit, but to me mainly it just seems to be higher interest rates. Current rates, and anticipated soon.
Realized volatility is actually pretty low lately, and the option prices have been persistently high and generally rising.

Jim

So would this be the equation for the implied interest rate?

call premium/strike price

So would this be the equation for the implied interest rate?

call premium/strike price

An example:
The Jan'26 $190 call would cost about $169, while the stock is $331.71

331.71 - 169 = 162.71 the amount "borrowed" to control a share

To exercise the call (at expiration) would cost $190. So 162.71 is borrowed and 190.00 is repaid, approximately 27 months from now.

(190.00 / 162.71)^(12/27) = 1.071 The implied annual interest rate is 7.1%

I understand perfectly now. Not intuitive though.

Jim: You might end up borrowing at a real 5.5% to see a value increase of a real 6.0%. Not great math.

I'd be interested to hear if you'd still make / are still making this trade, all else being equal, and/or how you'd think about the decision when the math is this close.

I can see how the risk/reward of an effectively permanent leveraged position in BRK has changed rather substantially, but if your (conservative) estimate of BRK's real growth rate is 6%, a +0.5% return every year is still a non-negligible boost to returns. The risk and reward also seem to cut equally both ways, assuming that a deep enough in the money call option won't expire worthless. So to me it still seems clear that the leverage is preferable.

I tend to trade in and out of my leverage (so I'd be waiting for the expected return to increase before I add leverage, and I'd drop it when the short terms prospects don't look as rosy), perhaps to my detriment, but I've begun to come around to the idea of holding a permanent or quasi-permanent leveraged position, if the cost of borrowing were to allow it. So I'm curious how you handle these close situations.

One aspect of long-dated BRK calls I've never seen discussed is that I wouldn't actually exercise the call. I would sell it (and possibly roll out) a year or so before expiration.

If you buy a call 2 years out and sell it one year out it will retain about 70% of its time value, which accounts for the implied interest. This means that the "interest" charged in the first year is only about 30% of the total, significantly lowering the implied interest rate.

I haven't had my coffee yet, so maybe this is an illusion.

If you buy a call 2 years out and sell it one year out it will retain about 70% of its time value

This is true if the price of the underlying is the same and the implied volatility is the same one year later.

A DITM call will lose more of its time-value as the underlying stock price rises -- I'm willing to accept that penalty.

The relative implied volatility a year later could be higher or lower. So one of the criteria for buying the DITM calls in the first place is to be sure that implied volatility is not unusually high.

I'd be interested to hear if you'd still make / are still making this trade, all else being equal, and/or how you'd think about the decision when the math is this close.

I'm, not sure. I'm making it up as I go along.

To date I have been hoping that the economy would crack, and the interest rate forecasts would fall before I have to roll too many at high implied rates.
So I have been partly delaying rolling my contracts, and rolling to dates with shorter expiration dates than usual.
But that has not only not worked, but worked against me recently. Any buying on dips will be of shares, not calls, for now.

I still expect a US recession, but the housing situation seems to have delayed it...a strange hangover from the free money years.
(so many people have locked in low-rate mortgages, nobody wants to sell or can afford to, so there is very low inventory, meaning marginal house price transactions are holding up oddly well, meaning people are still feeling the wealth effect and the banks are still over-optimistic about LTVs...)
I was expecting recession to set in some time this winter, but maybe a bit later now? There are certainly already big cracks showing in the pocketbooks of those less well off.

In any case, I try to remember I'm not borrowing the full amount.
If you buy a call with 2:1 leverage and a horrible 8% implied interest rate, the stock price only has to rise a nominal 4% to cover the "interest" payment and get you to breakeven.

Jim

so many people have locked in low-rate mortgages, nobody wants to sell or can afford to

Amen. We have a 2.5% mortgage, at the current rates my payment would double. To sell and downsize, I'd have a smaller and less desirable house and have a somewhat higher payment. Yes, there are a LOT of people in that position.

We are paying 2.5% while collecting 5.5% on CDs. Kinda laughing at all the people who bragged that they paid their house off before retiring. So much more important to not have a mortgage payment than to make net 3%. Not.

I told my kids a couple of years ago to refinance their ARMs to 30 yr Fixed. Took some convincing but they all did. One got 2.25%, making me jealous.

An example:
The Jan'26 $190 call would cost about $169, while the stock is $331.71
331.71 - 169 = 162.71 the amount "borrowed" to control a share
To exercise the call (at expiration) would cost $190. So 162.71 is borrowed and 190.00 is repaid, approximately 27 months from now.
(190.00 / 162.71)^(12/27) = 1.071 The implied annual interest rate is 7.1%

I want to compliment you on the succinct and comprehensible summary.
I can never say it with two words when I could explicate by utilizing a plethora!

Jim

I agree. I was the one trying to understand. Nothing explains things better than a simple math example.

I was looking at the implied interest rates built into the prices of various Berkshire calls.

For example, the lowest-strike BRK call for January 2026 has an implied interest rate of 7.60%.

A higher strike call (but not a super speculative one), for example strike $260, is showing an implied rate of 8.22%.


The move down in interest rates over the last 40 days has had a pretty dramatic impact on the implied interest rates Jim mentions above. The Jan26 190s look to be under 6.5% right now and the 260s are probably about 6.8%. I’m not a buyer at these levels but the lower rates are encouraging. Maybe there is another opportunity on the horizon.

Jeff

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