Post New

An expensive lesson I hopefully learned. May others profit from it:

I think it was Bluehorseshoe who said when he writes covered BRK calls he only writes them for a strike price at least 20% above current price, as he always thinks a sudden 10% or more jump up to be possible with Berkshire.

On 29.Jan 2024 I wrote 01/17/2025 $430 covered calls = 10% above the then $390 of a BRK-B share. I thought to be on the safe side as I thought a 10% jump possible too --- but couldn't imagine Berkshire wouldn't stay at such a high (relative to it's own price/book history) valuation for a full year. As we all know, it did not only stay there but was for a good part of last year even another 10% higher --- apart from a few very short-lived drops which were too short for me to action on them by buying the covered calls back.

A few days ago and especially today, around 1h ago, with only one more week remaining before having to say "Goodbye" to those shares (a full 1/3 of all my Berkshire shares) I used another opportunity to buy those calls back.

Outcome: 1 year ago I received a premium of $8.15. The average price paid to buy those calls back was around $19. So I had to give back the premium received and paid another 130% of that as penalty for stupidity or at least greed.

(Btw right now, just 1h later, they cost only $13.5 and it would be FAR cheaper to buy them back; the usual thing; in hindsight.......).

Greed, because anything less than the 2% I received ($8.15 premium when BRK-B was at $390) was too meagre for my taste. Therefore I didn't do the reasonable thing if one DEFINITELY(!) wants to keep his shares: To (as Bluehorseshoe does) sell covered calls only with strike 20% or more above the current stock price.

Lesson: If the premium for such a high strike (probably just $1-3, far below 1%) is too meagre one should NOT look at premiums for lower strikes --- and eventually give in to the temptation to sell those calls instead --- but should completely stay away from selling covered calls if it's important to keep one's shares (e.g. because they are favorably treated tax wise (which is the case here)).

1 year ago I received a premium of $8.15. ..

Certainly that isn't a very high premium. You may be right that it wasn't worth the bother.

But do remember the information available when you opened the position. The stock was at $390, so I'm guessing this was around February 2, give or take. Known book per B share was $242.27, so the stock was trading at 1.61 times book. You agreed to (conditionally) sell the stock at $438.15 per share, which was 1.81 times book per share at the time, or (conditionally) pocket some "free" cash. All you had to do was sit and wait to see which outcome obtained. Presumably you thought both sounded fine.

If nominal book had risen by (say) 9% by expiry (a little under a year at around 10%/year?), you'd have expected to be selling at net 1.66 times book-at-expiry. That too isn't exactly a bad exit at planning time, given that the 20-year average is under 1.4 times book.

You've closed for a realized loss of 19-8.15 = -$10.85, which is a drag--I'm sure it feels bad. But do bear in mind that this was a covered call position, not a naked short call, so you did have a long stock as well. That has gone up by a lot, and it's the sum of the two positions which matters. With B shares trading at $441 right now, and figuring in your realized loss on the options you bought back, you could still sell right now achieving a net exit of $430.15, which is still 1.47 times current book, meaningfully above what one could usually expect. As "bad" outcomes go, that's excellent.

I started writing calls against my longs earlier than you, so my initial breakeven was far worse than yours. I wrote shorter term ones, closer to the money, for much higher premiums. Each time they got old, I rolled them up and out for approximately zero net cash change. My mark-to-market total right now is negative, about -$2.70 a share I think. But the time value keeps eroding. If the stock price stays where it is now, I will have made an overall "extra" profit around 4.1% of my long position, fairly modest. But not a bad outcome given how much too early I started: this has been a longer stretch of high valuation than I expected! If the stock price fades just a bit more over the next few months, say $420ish, I'll have made a profit on the short-call side of about 8.1% of my long position. The absolute number is quite meaningful. Conversely if the stock soars and I just let everything get called away (latest June), the net exit price will be over $490 per B, probably in the general vicinity of 1.56 times then-current book.

Jim

I think it was Bluehorseshoe who said when he writes covered BRK calls he only writes them for a strike price at least 20% above current price, as he always thinks a sudden 10% or more jump up to be possible with Berkshire.<\I>

I don't think I said that because that's not how I think about my covered call selling. Maybe I should consider it, your outcome is quite a bit better than mine so far.

I was selling covered calls against my non-taxable holdings starting early in August of 2023. I was targeting my all in exit price, should the shares be called away, at about 1.55x to 1.60x known trailing BV at the time. I was targeting that because historically ~1.6x was the maximum multiple of book we had seen since 2008 and the share price only stayed there very briefly. Once again the market made a bit of a fool out of me but such is life.

I had virtually all of my shares in my non-taxable accounts called away by end of June of 2024. I was not as adept at rolling up and out like Jim, i think my all in exit was about $400 on average. Since then I have switched to selling BRK puts and letting my pile of cash earn 4-5% interest. With the additional put premiums I have so far been earning in excess of 10-12% annualized (keeping up with BV growth) while i wait for valuations to come back in line. There is little doubt the market will make if fool out of me to some degree again.

Jeff

You've closed for a realized loss of 19-8.15 = -$10.85, which is a drag--I'm sure it feels bad.
It does. But it's more than compensated for by the positive outcome of the largest bet I ever made. I posted on several occasions last year that I bought BRK puts. I started buying them too soon but as more BRK shoot up as more I "doubled up", bought more puts.

That worked out well. As the bet is now far smaller than at it's top (most of those puts are sold = less capital invested in the remaining ones) I just had a look at the result so far: All together there were 47 completed buy-sell transactions of BRK Puts since Feb'24 when I started to buy and sell them. BRK-B was at $410 then, so returned 8% since. Those 47 closed transactions added another 11% and therefore practically exactly made up for BRK-B's fall until now from it's top of $490.


I wrote shorter term ones, closer to the money, for much higher premiums. Each time they got old, I rolled them up and out for approximately zero net cash change.
How did you manage to do that? I could understand that in the first half of the year, with BRK constantly up and down. But since July most of the time BRK did rise only. There were very few longer stretches down you could use to buy back old calls without a loss.

Is there a board or location which contains people who worked as professional option traders or option market makers? Just one would do, thank you.

I have switched to selling BRK puts and letting my pile of cash earn 4-5% interest. With the additional put premiums I have so far been earning in excess of 10-12% annualized (keeping up with BV growth) while i wait for valuations to come back in line.

This has been a pretty good strategy in the recent stretch of reasonably high BRK valuations and reasonably high interest on cash. I mentioned it here https://www.shrewdm.com/MB?pid=711586943
I have done this too, but I haven't had them very much of the time--I probably should have done more.

The ones I did were almost all from mid June to end August. I closed them all fairly quickly because it was such a strong rally: if you've made more than half the maximum possible profit in 10-20% of the time, there is no need to hang around. I made an average of $8.29 a share not counting the interest on the cash. That works out to some absurd CAGR, though the dollar total was modest as I didn't do enough.

Jim

I wrote shorter term ones, closer to the money, for much higher premiums. Each time they got old, I rolled them up and out for approximately zero net cash change.
How did you manage to do that? I could understand that in the first half of the year, with BRK constantly up and down. But since July most of the time BRK did rise only. There were very few longer stretches down you could use to buy back old calls without a loss.

I cheated.
I rolled them to later dates, and higher strikes, but the strikes I used were sometimes only *a little* higher. So at the time I wrote many of them, they were already well in the money. This means I didn't get nearly as much time value, but the cash value was about right so that each roll was very roughly cash neutral.

A made up example, as I'm too lazy to dig into the trade records:
e.g., say I wrote four-month $420s when the stock was at around $415-$420. I tend to go for strikes very close to the current price since I like the boatloads of time value and don't fear exercise.
2-3 months go by and the stock has gone to $450. The positions is in a hefty mark-to-market loss and it will take a lot of cash to close it. ("this too shall pass", I tell myself)
I might close the $420s and write $430 or $435 expiring three months later for about the same cash value. The breakeven price rises each time I do this, though not as much as the stock price has risen. The difference is that my breakeven always goes up, but the same is not true of share prices : )

Aiming for the same cash value isn't because I'm obsessed with the cash in and out of the Berkshire section of my portfolio--it isn't a substitute proxy for profit and loss. Rather, it's because the amount of cash raised is equal to the maximum profit on the position. If you roll to a new call with about the same cash value, it also has about the same maximum upside. If Berkshire really did go down into the basement, those calls that I wrote with "little" time value would make a mint as the in-the-money value also goes away.

After having rolled up and out a few times, the weighted average "net exit" price (strike plus premium) of my currently open short call positions is about $493. I also have a mark-to-market loss at the moment on all the open and closed positions combined since mid 2023, less than $5 per share. The MTM loss is gradually shrinking as the time value erodes, and if the stock price stays flat here it will turn into a profit. If the stock price settles lower for a while, it will be quite a big profit.

Jim

Post New

Berkshire Hathaway FAQ

---

Contact Shrewd'm
Contact the developer of these message boards.