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Monday, February 26, 2024

Weekly Wrap-Up – Buffett’s Daring Derivative Deal Does Well

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 and neither Warren or I were really considering that as a likely outcome

Yes, part of using the PSW system of "Being the House" is to take the same risk as a casino does.  You may, as an individual, come into my casino and have a good day – hitting 00 on roulette 3 times in a row and making a 1,000% return against me.  But we, like the casino, are in it for the long game and we will play the odds not once, but 1,000 times during which statistics tend to take care of themselves.  Barring unforseen circumstances, Buffett's bet, like many of ours, risks 20% to make 100%.  If we assume the outcome of being right or wrong is 50:50 then making a seriew of bets that are 5:1 in your favor is a very good way to make money, isn't it? 

Of course Buffett is playing what we like to call the "long con" where he collects $5Bn on a 10-15 year contract against $1Bn worth of margin that costs him perhaps 3%.  Meanwhile, he could put that $5Bn into something that pays him 5% and, on that difference alone he would make $100M a year or $1-1.5Bn in interest, not a bad little side income while he waits for the contract to play out.  Now – what about inflation?  Even if the S&P performs flat for 10 years, 3% inflation would add about 40% to earnings so we've got some real handicapping going on here.   In fact, now that we can look at in in retrospect, what kind of nut would have bet against this trade, betting the S&P would drop 20% lower over 10 years?  Oh yeah – It was this kind of nut:

Coincidentally, at the same exact time Cramer was on TV lining up the suckers to bet against Buffett, I was on TV rallying the troops to buy whatever Cramer's sheeple were selling.  While Buffett chose to sell long index puts into the panic – something we very much endorse – we were a little more aggressive that day going with 13 trades that delivered a return of 469% over the next 6 months.  The strategies were the same – sell options to the people who were panicking, cover ourselves well and take a stand that the World would not come crashing down around us or, in the very least, that we'd be able to recover within a decade!  As Buffett often says about good value investing: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

"We've put a lot of money to work during the chaos of the last two years," Buffet says in his letter.  "It's been an ideal period for investors: A climate of fear is their best friend.  Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance…  When it's raining gold, reach for a bucket, not a thimble."  This is the same philosophy we use with our Buy Lists, which I usually publish during market pullbacks – when there are bucket-fulls of bargains to be had.  The rest of the time we prefer to pick our spots and this week we certainly picked a lot of them! 

In last Weekend's Wrap-Up I charted out our range and noted that I expected us to wedge between 10,317 and 10,414 with 10,380 acting as our "cha-cha line," around which the Dow can gyrate up and down.  I won't bother putting up charts here as it will seem like I'm just bragging about how on-target I was but you can go back to that post and simply re-use the charts for the week coming up as we are in virtually the same place – only we're a bit more bearish now as we feel the last two weeks were window dressing and we're looking for our blue lines to be tested and fairly surprised if we start taking out the reds! 

Monday Market Movement

I was sick Monday so I had little to say but I did pick ACI in the morning post based on some very real growth in Chinese consumption that made them look like a great bet at $22.57.  ACI collapsed all the way to $20.70 on Thursday's open and we had fantastic opportunities to scale into the position and we're already back to $22.50

  • ACI at $22.57, now $22.50 – down 0.1%
  • ACI July buy/write at $19.27/21.29 – on target
  • FCX short at $77.50 (from Friday), out at $71 – up 8.4%
  • TASR complex spread – on target
  • TASR Jan buy/write at $5.50/5.25 – on target
  • TBT Sept $43/50 bull call spread at $4.40, now $3.50 – down 20%
  • TBT Sept $44 puts sold at $2, now $1.75 – up 12.5% (pair trade)
  • SAH March $10 puts sold for .95, now .35 – up 63%
  • LLY 2012 buy/write at $25.05/27.53 – on target
  • GLD complex spread – on target
  • GLL Oct $9/10 bull call spread at .45, now .50 – up 11% (pair trade)
  • SRS July $7/8 bull call spread at .35, now .36 – even
  • AAPL Apr $180/185 bull call spread at $4, now $4.40 – up 10%
  • AAPL Apr $180 puts sold for $2.75, now $1.55 – up 44% (pair trade)
  • GLW Apr $17 puts sold for .57, now .53 – up 7%

Not a bad set of picks for a day when I took a nap between 10 and 12:30 (all the picks after ACI came in the afternoon).  Notice we don't buy any open calls – we are hedging, hedging and hedging in a choppy market yet we still manage to squeek out some nice weekly profits.  You don't have to go risk-crazy to make a nice return.  Ask Warren….

Testy Tuesday Morning – Coincidence or Confidence Game?

I noted that the action we had on Monday, combined with my observations of the previous week's action indicated that the market movement was, once again "fake, Fake, FAKE" so we flipped a little more bearish despite holding our bounce levels on Monday as I said at the conclusion of the Morning Post:

We’re positioned a little bearish here at the top of our range so we’ll just be sitting back and watching our levels today.  Shenanigans are likely to continue through Friday’s end of the month but down seems to still be the path of least resistance at the moment.

We had some worrying indicators from German Corporate Confidence, Italian Consumer Confidence, French Consumer Spending, US Commercial Lending and Case-Schiller didn't look all that great to me either, especially with the Fed MBS buying spree running to a halt on March 31st. 

  • ERY March $11 puts sold for .55, out at .35 – up 36%
  • SCO March $13 puts sold for .55, now .45 – up 18%
  • DIA $102 puts at $1, out at $1.45 – up 45%
  • AMED March $55 puts sold for $1.40 now $1.45 – down 4%
  • FSLR March $105 puts sold for $5.45, out at $4.75 – up 13%
  • TNA March $39 puts sold for $1.50, now .90 – up 40%
  • BRCD July buy/write at $4.32/4.66
  • PALM March $8 puts solf for .58, now $2 – down 244%
  • SII 2011 $42.50 puts sold for $6.30, now $6.20 – even
  • DIA March $104 calls at $1.22, out at $1.55 – up 27%
  • TBT Sept $44/50 bull call spread at $3.25, now $2.85 – down 12%
  • VZ Jan buy/write at $20.59/25.30 – on target
  • DRYS Jan complex spread – on target

All going very well except for the damn Palm play!  Of course, PALM dropped 20% the following day and was a dead trade but I don't count on everyone following the rules and taking trades down unless I specifically said they were off or call a general turn although, of course, they SHOULD be setting tight stops after 20% gains and stopping out or AT LEAST adjusting at 20% losses!!!  Now, scaling in is another matter entirely so let's stop for a little lesson on virtual portfolio management….

Let's say you do AT LEAST follow our position sizing rules and did not allocate more than 5% of your cash to short put play.  If you had, say $5,000 to allocate (out of $100,000 cash) and you did not scale in, "going for it" you would have been willing to have $5,000 worth of PALM put to you at net $7.42 or 673 shares – so let's say you sold 7 of the March $8 puts, collecting $406.  Assuming you paid no attention all week, didn't stop out and didn't roll, you now owe your put holder $1,400 for a $994 loss.  Notice that this was a TERRIBLE outcome but, even if you take the whole loss, you would "only" lose 1% of your virtual portfolio's cash.  That's on a trade that went 244% AGAINST YOU! 

Even with this loss you can adjust out of it by rolling the 7 March $8 puts at $2 ($1,400, $2,800 in margin at 50%) to 12 Jan $5 puts at $1.15 ($1,380, $3,000 in margin at 50%).  You still have $380 of the $400 you collected and your break-even on the trade drops to $4.60 – that's 24% below the current price, not a bad way to get yourself our of trouble

That, of course, is what to do when you play it wrong.  If you had scaled in, you would have sold just 3 puts at .58 in round 1 and now that we've shot up to $2 you could either do a similar roll with far less commitment or you could roll to 9 Apr $6 puts at .70, putting ANOTHER $30 in your pocket and dropping your break-even to about $5.60, almost 10% further down than we are now and you would STILL have the additional escape or rolling out the the Jan $5s, except you could roll out to just 3 or them. 

That's the flexibility you have when you are scaling in – EVEN when a trade goes horribly against you.  In both cases, because we were sellers and not buyers of premium, we remained mainly in the driver's seat and able to stick with a trade, even when the underlying stock dove 25% on us.  That's why I say:  It's good to BE THE HOUSE!

Which Way Wednesday – Bernanke's Turn at Bat

We were looking for the dead cat bounce off 10,300 and that's exactly what we got on Wednesday as Bernanke's happy talk testimony was so predictable, the actual pre-release of his statement that morning hardly waited a mention.  A lot of bad news came down the pike relating to Commercial Real Estate and, as is normal in this "Alice in Wonderland" market – that, of course, sent IYR back to $45. 

We, of course, are hip to this nonsense, which is why we went long on DIA Tuesday afternoon but we also still expected to test our 5% lines (Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620) so we were pretty much looking to bet a bounce either down from our tops or up from our bottoms but, either way, as I said that morning, it was going to be a wild ride

  • DBA Jan buy/write at $21/23 – on target
  • USO March $38 calls sold at $1.50 avg., out at $1 – up 33%
  • USO March $37 puts at .61 avg., out at .85 – up 39%
  • ERY March $12 puts sold for $1 out at .75 – up 25%
  • DIA March $102 puts at$1.05, out at $1.10 – up 4%
  • STEC May $10 puts sold for $1.30, now $1.25 – up 4%
  • CROX Jan $5/Apr $8 calendar spread at $2.50, now $2.60 – up 4%
  • EDZ July $4/5 bull call spread at .55, still .55 – even
  • EDZ Juy $4 puts sold for .35, still .35 – even (pair trade)
  • ACI Apr $21 puts sold for $1.25, now .80 – up 36%

Notice how we keep track of ACI and took advantage to sell puts.  As with Buffett, we see downturns in our positons as opportunities to buy more.  Not always, but when we feel the sell-off is unwarranted AND when we are early in our scale as this put sale constitutes round 2 of our 4 round entry.  All in all, it was an interesting day but we remained slightly bearish into the close being braver with our oil puts (as $80 was totally ridiculous) than we were with our index puts. 

That night Vitaliy Katsenelson gave us a Powerpoint on "Japan – Past the Point of No Return," which is some very scary reading but, nonetheless, I  went ahead and began our new $100K Virtual Portfolio as I thought we'd pull some good entries on Thursday's sell-off.  This is a conservative virtual portfolio looking to remain well-hedged for a very dull 2% monthly return – hoping to pull 25% for the year.  We do enough speculative trading during the week (see above below and everywhere else) and we're using the Conservative $100KP (there is also an aggressive one for fun) to teach good trading techniques and trade management

Bernanke CongressThursday – Bernanke's BS Bonce Part II

As we expected, Bernanke's sunshine and lollipop testimony couldn't stand up to poor jobs data and the market tanked harder and faster than we thought it would.   I pointed out the complete nonsense that was the CPI report – a report which Bernanke relied on to show what a great job he was doing and I got very deeply into the logic and morality of walking away from an underwater mortgage – perhaps if enough people simply start acting like middle-class businessmen instead of lower-class serfs, we CAN begin to change they dynamics that are wrecking this country.  Unemployment was far worse than expected and the market was down 170 points at the open but, as I said in the morning post:

Fear not my top 10% comrades – everything is fine up here on top, though, as Durable Goods were up 3%, that’s 100% more than what "expert" economists had predicted but right in line with my "Tale of Two Economies" theory as economists tend to be idiot acedemics who don’t understand the joys of "zero down-zero payments for 12 months" or the fact that if I lay off just one employee, I can buy Tina that new washer and dryer she’s been wanting (sorry Greg!).  Ah capitalism – you efficiently drive us to make the wise decisions….   I do think our 5% levels will hold (Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620) and tomorrow I expect a push back up. 

  • DIA March $104 calls at .90, now $1.15 – up 27%
  • TBT March $48 puts sold for $1.05, now $1.40 –  down 33%
  • TBT Apr $48 calls at $1.25, now .92 – down 26%
  • TNA $39 puts sold for $1.50, now .90 – up 40%
  • GME Apr $17 puts sold for .90, still .90 – even
  • ABX March $36 puts sold for $1.02, now .65 – up 36%
  • VZ July $29 puts sold for $2.02, now $1.82 – up 10%
  • CSCO July artificial buy/write – on track
  • AAPL Jan $180/200 bull call spread at $11, now $13 – up 18%
  • AAPL Jan $180 puts sold for $16.50, now $14.75 – up 10% (pair trade)
  • PALM complext spread – on target

While we played fairly aggressive in the morning, that AAPL trade was our last trade at 2:12 until PALM at the closel.  I said to Members at 2:18: "Done with my upside plays – that was enough fun for now!"  We already knew we were in the midst of a BS rally at the time and my comment at 3:44 was: "Wow, being bullish is such fun – you just place your bets and wait for something ridiculous to happen!"  Because we got such a big move back up, we got more cashy and neutral into the close.  My logic was: "We have the GDP in the morning and that should be about 6% but everyone knows that already so any miss would be dangerous.  I think we go up, I firmly believe we go up but I had a great week so why risk it?

Thank GDP It's Friday!

After discussing what BS the CPI number was on Thursday, we discussed what BS the GDP number was on Friday.  Our man Joe Stiglitz knows it's all BS and I had several links to him.  We also expected JPM, GS and co to pump oil and other commodities back up into the weekend and we managed to hit $80 again, giving us yet another nice entry to short oil.  Overall, though, it was a very weak move on the last day of the month and it left us a little more bearish than we had planned to be into the close

  • Oil futures short at $80, stop at $79.50 – pays $10 per penny per contract!
  • TM April bearish ratio backspread – on target
  • USO March $37 puts at .45, still .45 – even
  • TBT complext spread – on target
  • ACI Apr $22 puts sold for $1.20, still $1.20 – even

That was it on this indecicive day.  There were a lot of silly in and out plays on DIA puts and calls that weren't worth mentioning as they made pennies but those pennies do add up and our Aggressive $100KP, which is where I log those trades, was up 14% for the week so it is important to learn to grab those momentum plays if you are a day trader – but it's also important not to even play those trades unless you have a lot of experience and a good sense of virtual portfolio management.  On the whole, not a bad week at all – just 6 losing trades out of 54 (11%) for an 89% winning percentage.  I myself made a critical mistake in the Aggressive Virtual Portfolio as I left some DIA puts open into the weekend, forgetting I was not going to be around Monday morning. 

I'm looking for some Dollar strength, Euro weakness and a commodity pullback early in the week but certainly not so much that I think it's wise to leave a day-trade on the table until I get back to the action Monday afternoon.  It could be a costly mistake – we'll find out tomorrow.  My other open positions in the aggressive virtual portfolio are bullish plays on TBT, a whole lot of USO $37 puts and a long play on SPWRA.  Likely I'll be in a foul mood if we have a commodity rally that moves the Dow up on Monday but it will be my own fault – as I often say to members – CASH is so much more flexible!



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