Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A) ❤
No. of Recommendations: 21
Just a talking head moment, feel free to ignore.
Since around the third week of September, Berkshire has been underperforming other S&P 500 companies, cap weight or not.
Anecdotally, I have noticed that trends of outperformance and underperformance tend to change direction at year end, as portfolio managers do window dressing and change their tracking error career risk tolerance level.
At end 2022, the outperformance suddenly turned into underperformance.
At end 2020, the underperformance suddenly turned into outperformance.
At end 2018, the outperformance suddenly turned into underperformance.
At end 2015, the underperformance suddenly turned into outperformance.
Consequently, I think there is a slightly better than even chance that Berkshire may start outperforming other big stocks for a little while, starting right after the new year.
A graph of the relative performance. Horizontal line means market tracking.
https://stockcharts.com/h-sc/ui?s=BRK%2FB%3ARSP&p=...Jim
No. of Recommendations: 1
I was waiting for this post!
No. of Recommendations: 0
Hmmm, if I were feeling a bit light on LEAPS due to selling in the summer, would this be a better than average, neutral, or worse than average time to sell stock and buy 2026 Calls?
No. of Recommendations: 11
Hmmm, if I were feeling a bit light on LEAPS due to selling in the summer, would this be a better than average, neutral, or worse than average time to sell stock and buy 2026 Calls?
If you're keeping the total number of shares of exposure the same, selling X hundred shares to buy X calls, this is probably not a bad time.
Stock price high-ish, market calm. A good day in general to be a net buyer of time value.
The only fly in the ointment is that I think interest rates are going to come down, so the rates built into the calls might (?) be better some time in 2024 than they are now (mostly 6.5-7.5%). Or not--hard to say.
Conversely, if you're thinking of using all the stock proceeds to buy calls--as an addition to your total position size--no, I don't think today is a great day to do add. The stock isn't cheaper than average today, so I don't see it as a particularly auspicious time to add to your position. I have a hunch (worth no more than the money it's costing you) that the stock price may be lower in absolute terms some time in the next year. Kind of a bummer for me, as I would like to be adding--I have a "liquidity event" coming next month and for me the best thing would be a tanking price so I could load up at a great entry. I hope nobody minds if I hope for a brief crash?
Jim
No. of Recommendations: 7
I am going to put out there a theory. I would surmise that more so than any other stock, that people gift shares to trusts near year end that will be sold immediately by the trust regardless of price.
I use the Schwab trust and most of my trust donations happen the last few weeks of the year.
You want to give away the largest % gain long term investments in your portfolio to maximize the benefit.
BRK is likely number #1 for many.
No. of Recommendations: 0
If you're keeping the total number of shares of exposure the same, selling X hundred shares to buy X calls, this is probably not a bad time.
Stock price high-ish, market calm. A good day in general to be a net buyer of time value.
The time value still offets the stock price gains -- so what is the benefit? Freeing up money to buy something else?
Also, what is the benefit of a high-ish stock price?
Educate me.
No. of Recommendations: 14
The time value still offsets the stock price gains -- so what is the benefit? Freeing up money to buy something else?
Yes, it would just be freeing up cash.
You're locking in profit and taking money off the table.
That money can be invested in something else now, or held for a good upcoming opportunity, or (my fave) simply spending the money.
Also, what is the benefit of a high-ish stock price?
This is in the context of rolling an option up, or out, or switching from stock to calls, but not increasing the number of shares you are long.
The time value in an option is highest when the stock price and the strike price are the same.
The time value is higher and lower at higher and lower prices, sort of a bell curve.
So, for any GIVEN in-the-money strike price, the higher the stock price is at the moment (the farther above the strike it is) the lower the time value cost to buy that option.
[the in-the-money cost is higher, but you're selling something else at a higher level too, so that part is a wash]
Hence, the lower the breakeven price and the lower implied interest rate for the "borrowed" money.
If you're going to be buying a call at any specific strike, the time value in that particular call is cheapest when the stock price is way above it.
Since this is true of each strike price, it's true of all of them: no matter which strike you're buying, you want to be buying it (specifically rolling something into it) when the stock price is as high as possible.
So, on days that you are a net buyer of time value (rolling options out to a later date, for example), you want the stock price to be high.
This is obviously not the same logic when you are simply adding to a position. The higher stock price dominates the discussion and you're just getting a poor entry price.
My own investment and income strategy could be summarized as follows:
Buy a lot of stock and/or calls when Berkshire is really cheap.
When it's more expensive and I need some money, sell some to raise cash for expenditures.
When it's more expensive and I don't need money, roll some stock or deep-in-the-money-calls to higher strikes while they're cheap, freeing up cash and building a cash pile.
Repeat.
Over time the number of shares I'm long doesn't really change. I'm long about the same number of shares as I was in 2002. I just pump some money out of the portfolio as the strikes I'm using gradually ratchet higher, though they're all "in the money" by around the same percentage. This fun will all end when I no longer find calls that are available at implied interest rates that seem attractive relative to my expectations for the stock price trajectory. Then it will be back to simple stock again. But while it lasts, it's great.
One interesting thought is that, to the extent that I'm making a living from the option market rather than actually being an owner of Berkshire Hathaway the company, I am playing in the zero-sum part of the markets: it's just a side bet on how Berkshire stock is doing. So for every dollar I've been making this way, someone else is losing it.
Jim
No. of Recommendations: 3
Thanks Jim for your generosity in teaching with such clarity. I must admit, it’s added a bit more fun (and profits) by “dipping my foot” in the DITM call LEAPS although I have plenty more to learn.
Happy Holidays to shrewds everywhere and a healthy, peaceful and prosperous 2024!
No. of Recommendations: 1
Thanks Jim for your generosity in teaching with such clarity. I must admit, it’s added a bit more fun (and profits) by “dipping my foot” in the DITM call LEAPS although I have plenty more to learn.
I second that "thanks".
I've been using options for more than a decade and I am amazed at the endless ways of making (or losing) a buck with them. I finally got away from selling cash secured puts in Spring 2020 when the steamroller caught up with me.
DITM calls when BRK is cheap and covered calls when it is expensive have been my only recent uses of options.
Now I need to compare the upside and downside of this new (to me) use of DITM calls for when BRK is not cheap.
No. of Recommendations: 2
Me: Also, what is the benefit of a high-ish stock price?
Jim: This is in the context of rolling an option up, or out, or switching from stock to calls, but not increasing the number of shares you are long.
If switching from stock to calls, then I see how one could get some spendable cash while controlling the same number of shares.
But to eventually get back to the same number of shares of stock you'd have to pay more than the cash you took out originally. And the time value of your calls will have been eroding the whole time.
What is the long term benefit? Don't you need some leverage at some point to generate the cash you spent?
No. of Recommendations: 12
If switching from stock to calls, then I see how one could get some spendable cash while controlling the same number of shares.
But to eventually get back to the same number of shares of stock you'd have to pay more than the cash you took out originally. And the time value of your calls will have been eroding the whole time.
What is the long term benefit? Don't you need some leverage at some point to generate the cash you spent?
Well, you can look at a few ways.
In the first instance, consider the situation that you don't really intend to change the size of your position in terms of share count.
It's true that shifting back to stock later on would use up a lot of cash and your net result would be that you had simply increased your average breakeven cost.
The benefit in this case, if any, is the incremental profits you made on whatever you did with the cash that was freed up. Switching from cash to calls for a while to buy something else at a huge discount may hurt your Berkshire breakeven a bit, but may help your overall portfolio...you'd have to consider the whole portfolio effect.
Another more aggressive/risky way to look at that same "constant position size" situation is simply to think of never switching back to plain stock. If you own the same number of calls for a decade, the extra leverage adds to your long run return provided the average nominal price rise of the stock priced is greater than the average implied interest rate you're paying for the "borrow" built into the calls. Each time the calls are rolled, they are rolled to a later date and [on average] a higher strike price, freeing up cash, yet the degree of leverage is never really changing because each new call is purchased at a strike which is a similar percentage below the stock price. This describes a good chunk of my portfolio. It doesn't free up cash very frequently, but averaged over time it's substantial.
In the second instance, the changes between stock and calls may also entail a change in your position size. The simple observation here is that sometimes the stock is more expensive than at other times. If you are adding to your position when it's cheaper (indulging in a pinch of leverage via calls), and lightening when it's not so cheap (no leverage or less leverage), you're probably getting an extra boost from the leverage.
In round numbers, if 2:1 leverage is costing you 6%/year rate on the implied borrow, the stock has to rise at a rate of [only] 3%/year (nominal, not real) for that position to be a breakeven and the stock has to rise at a 6%/year rate for the cash allocated to the position will do as well as the same amount of cash allocated to plain stock. If the stock rises more than 6%/year during the stretch you own the calls, the leverage turns out to have been a winning wager.
As always, one has to bear in mind that the fun of leverage from calls may come to an end. There may be a day that the calls are no longer available, or no longer available at an implied interest rate that looks good relative to one's expectation for the rise in the nominal stock price. But so long as the fun lasts, it can be fun. I like to keep a spread of expiry dates, tilted towards the distant future, as the fun might end at any time and I wouldn't ever want to be in the situation of having to reduce my position size by a lot while the stock was unusually cheap. I'd live, but I'd be grumpy for a bit.
Jim
No. of Recommendations: 18
Consequently, I think there is a slightly better than even chance that Berkshire may start outperforming other big stocks for a little while, starting right after the new year...
Well, it's early days yet to say the least for testing my prediction, but:
S&P 500 so far -0.97%
Berkshire so far +1.41%
Also I'm not too displeased with 2024 so far on other fronts:
DG +3.68%
HSY +2.68%
Jim
No. of Recommendations: 7
Well, it's early days yet to say the least for testing my prediction, but:
S&P 500 so far -0.97%
Berkshire so far +1.41%S&P 500 year to date so far -1.23%
Berkshire year to date so far +2.48%
It might not be a meaningful amount, but as the trend change started precisely at year end I'll claim success from the dumb prediction : )
This is a graph of the ratio of Berkshire's price to the S&P index total return.
https://stockcharts.com/h-sc/ui?s=BRK%2FB%3ASPY&p=...A horizontal line means Berkshire is tracking the market, an up trend is outperformance.
The direction is good and the timing of the turnaround was right, but we still haven't unwound the underperformance between the equinox and the solstice.
Jim
No. of Recommendations: 7
S&P 500 year to date so far +5.37%%
Berkshire year to date so far +13.38%
Advantage BRK 8.01%
Possible conclusion: Money managers are more predictable than the stock market is.
Jim
