Weekly Wrap-Up - Buffett’s Daring Derivative Deal Does Well
by Phil - February 28th, 2010 9:30 am
I was going to talk about Buffett’s annual letter to investors.
Fortunately, I procrastinated and other people did some detailed reporting like Ravi Nagarajan, Andy Fry, Scott Patterson and Joe Del Bruno - who does a great job of pointing out that Berkshire’s 4th quarter results were propped up by Buffett’s $1.05Bn gains in derivatives betting (something Buffett himself once called "weapons of mass financial destruction" but, as we well know - if you can’t beat them…), which accounted for 1/3 of Berkshire’s $3.06Bn profits.
Buffett’s biggest bet was selling a put against the S&P 500 back in March - a move I said at the time was BRILLIANT and Buffett himself now says about his own options trading: "We are delighted that we hold the derivatives contracts that we do. To date, we have significantly profited from the float they provide. We expect also to earn further investment income over the life of our contracts."
What did Buffett do? Exactly what we teach you to do here at PSW - he took advantage of an irrational move in the markets and SOLD INTO THE EXCITEMENT, getting a fat premium from some sucker that bet the S&P would not hold 666 5 years from now. Buffett effectively sold $5Bn worth of puts that expires worthless at S&P 700 between 2019 and 2027, putting $5Bn in his pocket and holding aside $1Bn in margin, which is how much he’s already ahead on the bet. Like a good options trader, he has a plan and he’s trading his plan, making sure his investment is on track and patiently letting time do it’s work as it eats away at the put-holder’s premium.
What about the risk? Well I can’t speak for Buffett’s stop-loss technique but we’re talking about a company that has (had) $40Bn in cash using their excess margin to make a $5Bn bet that the S&P would not stay below 700 for 10 years. Buffett and I both tell people - NEVER buy a stock (or sell a put against one) that you are not willing to own for 10 years. The S&P was 5% below at the time and would have had to drop, perhaps, 20% more to cost him $1Bn so let’s call the stop 550 on the S&P where Buffett risked 2.5% of his cash against a posible 400% gain on his $1Bn risk allocation over 10+ years. While it is true that if the S&P dropped 50% in one day Buffett would be in deep trouble - sometimes you do have to play the odds…
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Barrons.com Videos
by ilene - September 6th, 2009 1:06 pm
Here’s a couple videos from Barrons.com. H/t Barry Ritholtz.
Barron’s Steve Sears reports that professional investors are hedging September. Besides words of caution, he sounds surprisingly bullish, suggesting some people think it’s a good idea to buy the dips (hedging the comment too). - Ilene
The Smart Money is Preparing for a Market Downturn 9/3/2009
Why the Rally Still Has Legs 9/2/2009
"This week’s slide doesn’t mean the ‘recovery trade’ has ended, says Barrons.com’s Bob O’Brien."
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Investing Education Advice if You’re New to Options Trading
by Phil - July 3rd, 2009 3:17 pm
By Travis W of PursuingWealth.com
Finding investing education advice for stock options trading can be a frustrating endeavor at times. New traders often share with me that it feels like the options trading community is a very tight-lipped community with a high price of admission. I’ve been through that process so I’d like to offer you some advice.
Learning to invest your own money is a journey, not a destination. It takes time, patience, and education. It’s a proactive journey for those who no longer desire to be a victim of the so called experts.
Over the years I’ve made enough mistakes and have had enough successes to know that the ability to master your money is not something that just happens. It takes a bit of work on your part.
Increasing your investment IQ is a key part, especially when you’re dealing with stock options. You have to find a qualified and trustworthy source for investing education. There’s quite a bit of hype out there so you have to filter out all the "noise".
You may have already searched online for information on stock options, or read a few books. Most people are drawn to options trading by the potential to create large sums of money in a short period of time. Here is my forewarning; having a great deal of head knowledge about stock options doesn’t necessarily mean you’ll be a great trader. It’s going to take some real world practice.
Most of what I’ve learned about investing did not come from a classroom or a book; it came from real world experiences. I found people who were willing to give me unbiased investing education and I applied the knowledge through practice and a bit of trial and error.
Investing Education is your Financial Road Map
Investing education has a purpose in our lives like a map has a purpose to a traveler. A map can take you from point "A" to point "B" when you’re traveling. Investing education can take you from school loans, credit card debt, and no budget to debt-free with money to burn. It’s your financial map so to speak.
You could try to figure out options trading on your own, but if you’re smart and value your time you’ll find a map that can get you to your destination quicker. It’s extremely rare for me to meet someone who doesn’t want to provide additional income for their family, position themselves to retire early,…
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Hedging Your Way To Healthy Dividends - Part 3
by Phil - May 25th, 2009 5:56 pm
We’re going to go out with a bang here and give you a 3-for-1 in this final post on the issue.
In Part 1, we discussed the idea of going after former dividend payers who may bounce back while creating an artifical dividend through option hedging. In Part 2 we looked at using the buy/write strategy to give ourselves a nice discount on the stock, giving us a 30% hedge on the stock on top of the dividends. Today we will look at a couple of ways to play the safer bets and how to simply and effectively boost your dividend yield while also protecting your investment.
In Tuesday’s post we had 21 dividend payers divided into 3 categories. We’ll look at what we consider a "pretty safe" dividend payer, PGH, who pay a MONTHLY dividend of about 8 cents on a $8.11 stock (12%) as well as our long-time favorite, KMP who pay about $1 per quarter and our Blue-Chip selection will be CAT, who have a 4.9% dividend and are trading at a nice, cheap $34.31.
As we have 3 trades here I’m not going to go too heavily into the merits of each one. Suffice to say we like them at these prices and we like the option hedges we can put to work on the postions…
PGH is a stock we went crazy for back in March, when they were under $5 but that was when they were in the category of stocks where people felt the dividend was in jeopardy. It didn’t take much for them to fly back to $8.11 but, through the magic of hedging, we can knock that price back to an entry price of $5.29 by selling the Jan $7.50 puts and calls. As always, our major risk is that the stock falls below $7.50 and another round of shares are put to us at that price on Jan 15th. That would create an average entry of $6.40, which is 21% below the current price. Should we get called away as $7.50, that would be a $2.21 gain on cash so 42% PLUS 7 months worth of dividends, perhaps another .56.
Sticking with our $5,000 per position maximum risk, we can make the play the following way:
- Buying 400 Shares at $8.11 ($3,244)
- Selling 4 Jan $7.50 calls for $1.50 and 4 Jan $7.50 puts for $1.32, netting $2.82 ($1,128)
- If the stock is put to us on Jan 15th we will own 800…
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Hedging Your Way To Healthy Dividends - Part 2
by Phil - May 24th, 2009 7:46 am
Time to get a little more conservative…
In Part 1 of this post, we talked about the potential long-term value of taking a chance on companies that used to pay dividends but don’t at the moment. In addition to the 7 selections we had last Tuesday, I would urge members to keep on the lookout for additional prospects we can discuss as the long-term benefits of catching these stocks at the lows can be amazing! This was the same logic that led me to pound the table back in March on C, BAC, WFC, JPM and even the hated GS - stocks that have tripled or better in just 3 months.
We had a very easy time selecting those stocks as we were able to hedge our entries and our long-term logic was that, at those low prices, we could be fairly sure of producing a good option income even if they never restored the dividends but the kicker was the possiblility of owning, for example, C at $1.50 down the road when they go back to paying $1 per year dividends. Imagine having a year’s salary put away on stocks that pay you almost a year’s salary every year in dividends alone!
Don’t worry, you didn’t miss a once-in-a-lifetime opportunity, we just have to work a little harder at the moment. As I noted with our LYG example, there are still beaten-down financials that are worth a look and today we’ll look at 2 more of our 21 Tuesday selections (one now, one later) and go over the trading plans for those positions. Note that the LYG trade ties up just $1,035 in cash to make (hopefully) $1,465 in year 1 with a commitment of $3,535 if you end up owning all 1,000 shares on Jan 15th.
By making sure you are on top of these figures, a person making $30,000 a year who has $5,000 in an investment account count take a modest 6-month gamble like this. If this trade pays off, $5,000 becomes $6,465 and 500 LYG shares are secure (about $2,500 worth) or, at worst, you have 22% more cash for the next trade. The next trade secures another potential dividend payer and if every 6 months you can secure just another $2,500 worth of dividend paying stocks for under $2,000 then in just 10 years, investing just 10% of a $30,000 annual salary, you could, very conservatively, have $50,000 worth of dividend paying stocks supplimenting your…
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Vacation-Proof Your Portfolio
by Phil - May 23rd, 2009 3:30 pm
A couple of years ago, Option Sage (Gareth) and I put up a very popular article titled "Vacation-Proof Your Portfolio."
In it we discussed several strategies for hedging existing positions, moving them into neutral positions ahead of a time when you would be going away and not able to keep your eye on the markets. As we cashed out last week, it hasn’t been much of an issue coming into this long weekend but some of you still have long postiions that need protecting and Sage has been kind enough to provide us with access to a free on-line seminar on the subject through his educational platform at www.MarketTamer.com.
I don’t recommend many services but Sage was an original member who went on to write many of our educational posts over the years and went on to develop an on-line trading education system that is very, very good for learning stock and options trading. PSW members get a special offer of $99/month, which is 1/3 the going rate AND he will give you that $99 back if you are not satisfied after the first month! So check out the link above, there are 3 free lessons there and read through the article. If you plan on going away with positions open this summer in this crazy market - I think it will be time well spent…
Those of you who know Sage have probably already linked over but for those of you who didn’t get a chance to meet him when he was on-line with us all the time, here’s a copy of Market Tamer’s recent press release, which tells you a bit about Gareth and the company he’s been building:
Taming The Market
A shockingly simple yet amazingly powerful concept has been ignored by major hedge funds, mutual funds, and retail traders alike. On their quest to outperform the market, Wall Street’s best often get sucked into a single style of investing or trading: long only, long/short, distressed, diversified and the list goes on. They use a single approach to exploit a changing market. And often a single approach works - for a while. Bill Miller of Legg Mason was regarded as one of the stars on Wall Street until his portfolio suffered substantial losses during the crisis of 2008. Victor Niederhoffer was once acclaimed as the number one hedge fund investor in the world until his fund blew up. And in the past year countless others have…
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$100,000 Hedged Portflio Update
by Phil - April 18th, 2009 4:39 pm
We didn’t do a wrap-up last week as I instead wrote a long, Members Only post (only Part 1 too) on "Setting Up A $100,000 Hedged Portfolio" concentrating on a virtual $20,000 allocation in the financials for our first sector.
We’re going to do more of these on the weekends as people find them useful and also because, although they are very popular, I do get tired of just reviewing what we did for the past 5 trading days every week. So maybe a little of both today but I aim to keep this short (as I usually do, but it never works out) so we can do another post on earnings plays tomorrow.
How is our new sample portfolio looking after a week? Well let’s see:
- 500 UYG at $3.48, selling 5 May $3 calls for .72 and 5 May $3 puts for .28, net $2.48/2.74
- UYG now $3.79, May put and call combo now $1.12 = net $2.67 ($95 profit on $1,240 = 7.7%)
- Selling 2 FAS $7.50 puts for .45 naked
- FAS closed at $9.40 so 100% profit of $90
- 500 C at $3.04, selling May $3 puts and calls for $1.11, net $1.93/2.47
- C now $3.65, May $3 put and call combo is $1.19 = net $2.46 ($265 profit on $965 = 27.5%)
- Selling 2 IYF May $36 puts for $2 naked
- IYF closed at $40.26, May $36 puts $1.20 ($160 profit on $400 =40%)
- Selling 2 JPM May $29 puts for $1.95 naked
- JPM closed at $33.26, May $29 puts $1.17 ($156 profit on $390 = 40%)
- Selling 7 FAZ May $10 puts for $2.40 naked (adjusted to reflect Monday’s gap down open)
- May $10 puts are now $2.67 so a loss of $189 (-11.3%). Both our July and Oct escape rolls are still intact so no worries here anyway (this is a hedge to the others)
- 5 FAZ Oct $12.50 calls for $4 (adjusted), selling 5 May $21s for $1.05, net $2.95.
- The Oct $12.50s are now $3.29, May $21s are now .45 so net $2.85, a loss of $50 (3.4%)
So far so good! The FAZ hedges are holding up nicely while all of our upside plays were winners. Our 3 April put sales are expired $90 in profits so risk off the table and cash put back to work and May Put sales look safe enough at the moment, up $316, while the May option plays are up $360 against a $239 loss on the hedges. Overall, we put less than $1,500 of capital to work (there were, of course, some margin requirements - see original post) to make $527 in a week. While…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
(