What's this mean about Buffett ?

[Delawaredave]

MSN from FT has below article on Buffett's selling market index put contracts:

http://news.moneycentral.msn.com/provider/providerarticle.asp?feed=FT&Date=20060404&ID=5616836

Stupid question:  What did Buffett do ?   Someone bought the right from Buffett to sell at today's higher price an index if it goes down ?

So Buffett's betting long term the indices will go up - the initial contracts will be worthless - and he pockets the original option price - correct ?

Interesting that 3 of the 4 indices are international.

I don't know if the article is written confusing, or I am stupid, or both....

Thanks

 

[2B]

Buffett is an avowed conservative bull.  He projects modest growth for the world stock markets.  He's putting his money where is mouth is by "insuring" against major market drops for large pension funds which would like to be more aggressive in the face of low bond yields.

 

[Gone4Good]

A very smart thing to do.

It appears as if Buffett sold very long-dated puts on a handful of indexes. Which means he gets paid a premium up-front in exchange for the promise to sell the index to the option purchaser at fixed price 15-20 years in the future. So he gets paid today, for taking the risk that equity markets will be lower in 15-20 years. The beauty of this deal has several facets.

1) Developed equity markets very seldom have 15-20 year periods of negative returns. I'd view the fact that 3 out 4 contracts were non-US as mere diversification, rather than an indication Buffett has reservations about the US stock market. If he thought the US market was in trouble, he wouldn't be selling puts, he'd be buying them.

2) The nature of a put is that it will not get exercised until expiration. Therefore Buffett pockets his premium today and won't have to make good on the contract for another 15-20 years. He'll likely have to mark the position to market on a real-time basis (unless he can somehow qualify for hedge accounting, which would be an added benefit) but cash out the door will be minimal even if his position is under water.

3) Considering that no one else is offering index puts for anywhere near as long as 20 years, the premium Buffett is receiving is probably extreme relative to what an option pricing model would calculate.

 

[Nords]

3) Considering that no one else is offering index puts for anywhere near as long as 20 years, the premium Buffett is receiving is probably extreme relative to what an option pricing model would calculate. 

Knowing Buffett, it's downright confiscatory.

He didn't have to sell anything and those funds must have more money than common sense because they sure didn't have many choices to shop from.

 

[Gone4Good]

Knowing Buffett, it's downright confiscatory. 

He didn't have to sell anything and those funds must have more money than common sense because they sure didn't have many choices to shop from.

Could be that they are repackaging the put as a "protected equity index" product for retail customers and making a nice little spread for themselves.

 

[Nords]

Could be that they are repackaging the put as a "protected equity index" product for retail customers and making a nice little spread for themselves.

I guess we'll know that when he plunks down the rest of Berkshire's $40B cash stash...

Is it just a coincidence that the stock has backed off its high in the last week or so? With this volume I can never tell what's happening unless it moves a lot more than that.

 

[Craig]

I'm not an options expert at all ... I always have to pause and remember my puts / calls.

A thought ... with such a long term, isn't it possible that Warren believes that some time, in the next 15 to 20 years, the markets will drop enough that he could simply buy those puts back (or sell calls to cancel) when they've dropped to a price less than his recent sale price? I could see that working, and he has time to find that right drop in the market.

 

[Gone4Good]

isn't it possible that Warren believes that some time, in the next 15 to 20 years, the markets will drop enough that he could simply buy those puts back (or sell calls to cancel) when they've dropped to a price less than his recent sale price? 

No. If priced correctly the option premium on the put will go up if the index price goes down. So, generally speaking, if the index price declines it would cost him more to buy the put back than what he originally sold it for.

Make no mistake, his selling 20-year puts is a long-term bullish bet on global equity markets.

 

[laurence]

Dude! Homboy is most likely worm food in 20 years! This is a scam for him on so many levels!

He's a market mover now, he makes money just by pointing - "Silver, I dub thee undervalued!" - Poof, Silver rockets up...

 

[Gone4Good]

Dude!  Homboy is most likely worm food in 20 years!  This is a scam for him on so many levels! 

He's a market mover now, he makes money just by pointing - "Silver, I dub thee undervalued!" - Poof, Silver rockets up...

Could be . . . but which indexes did he sell puts on again?

Oh, and he won't make any more money if the indexes go up. Even if they did, I doubt the Buffett aura will last for 20 days on an entire index let alone 20 years.