No. of Recommendations: 1
I must be missing something, the general idea is "lever up by buying DITM calls and use the `savings' to buy put protection".
Crazy - use leverage for protection. But the numbers below seem to work. Probably am missing something below:
Feb 27 2024: BRK 494 VIX 18
Suppose you bought the 50% DITM BRK call below (discussion will be `per share' for simplicity, and not `per contract'):
Jan 15 2027 (687 days) strike 250 call bid 267.50 ask 272 mid 269.75
You `saved' 494-269.75= 224.25 by controlling shares with the DITM call compared to buying shares outright. I initially won't consider the `implied interest' because the following discussion is about the larger issue of the title (can circle back to the interest later).
What can you do with those savings?
Consider buying put protection.
ATM puts might be nice, let's consider that:
You could buy long life-time puts and roll them periodically. Longer lifetime puts can be cheaper when considered on a per day cost than shorter maturity, but I want to consider worst cases below as a sanity check.
So consider buying ATM puts of lifetime about 90-120 days out and rolling them somewhere around 65 days to minimize time decay. In this scenario, you're keeping a tight floor under the share price with puts.
How do the numbers look?
Here's a candidate put:
June 2025 (113 days): put strike 490 bid 13.65 ask 14.80 mid 14.25
The idea is to use $14.25 of your $224.25 `savings' to buy ATM put for 113 days (which you'll roll about 65 days in). You'll keep doing this over the 687 day lifetime of the call.
Time decay of the 113 day put won't be too significant at the 65 day mark, so the remaining downside as far as just selling your put on the roll is concerned is that BRK could have run up during the 65 days. The share price at roll time could be far away from the put strike, which decreases the put value on the roll, so maybe you get near half the initial cost on the roll???
But don't guess, consider a worst case scenario where you get nada, zippo, zero for your put on the roll, i.e. an unrealistic worst case:
You'd be buying puts and losing about 14.25 every 65 days for the life of the call of 687 days.
So you'd be doing this 687/65 = 10 times. In this worst case scenario you'd lose roughly 10*14.25 or 140.25 of your 224.25 `savings'.
Sure, anything might happen on the roll e.g. volatility might be higher or lower or whatever, and all this affects the put prices. But assuming the worst case scenario provides hopefully a decent base case to begin to draw some conclusion about the general idea of "lever up with DITM calls to buy put protection".
After all the assumed put rolling, you `saved' 224 less the 140 spent on the ATM puts, so a net savings of 224-140= 84.00
As a percentage of the share price at the time of buying the call, you netted a savings of 84/494 = 0.17 or 17% discount over buying shares outright AND you had good put protection!
The above was worst case for the put roll.
But maybe you get (???) half of the initial put cost on the roll on average, then your net `savings' is 224-70= 154, or as a percentage of the share price at the time of buying the call, you netted a savings of 154/494 = 0.31 or 31% discount over buying shares outright AND you had good put protection.
Finally, consider a "worst, worst case" scenario:
Assume I got it wrong in the scenario above and the puts generally cost, say, twice as much.
Redo the simple math above, you're still effectively long BRK, AND with good put protection.
What do you give up?
You give up a good part of the leverage of the DITM call - but that's the whole idea, you lever up to buy protection.
And course, what you don't lose (via near ATM put protection), you don't have to regain, Buffet's rule #1.
You give up the security of owning the shares outright, i.e. maybe DITM calls won't be available at some point, but that's a general issue not specific to this particular use of DITM calls.
There are lots of variations of this crazy idea of "leverage buys protection":
Different underlyings, different ways to lever, etc ...
