The Buffett Put Trade – 2Q2016 Update

Each quarter Berkshire Hathaway, like all investment firms, files their holdings with the SEC.  Most people scramble to see what stocks Warren Buffett has been adding to his portfolio.  I usually scramble as well, but I’m looking for something hardly discussed in the dozens of pages that make up Berkshire Hathaway’s 10-Q.  I go looking for an update on what I commonly call The Buffett Put Trade.  Back in April I wrote an explanation of what this trade is all about.  You can check that out here A Buffett Put Trade Refresher

The short version is that between 2004 and 2008 Berkshire Hathaway entered into a few dozen over the counter option trades.  They sold at the money puts on four broad based equity market indexes: the S&P 500, FTSE 100, Euro Stoxx 50, and Nikkei 225.  These trades resulted in Berkshire taking in a total of $4.5 billion in premiums.  The chart below shows the monthly performance for each of these indexes since Berkshire began entering into these trades in through the end of the second quarter of 2016.

Buffett Price Charts

Source: Bloomberg 

Because these are over the counter trades we don’t have a full picture of the positions.  We know the premiums received and also the four indexes that are the underlying markets for the short put positions.  We also know that in 2010 some of the positions were closed out and a $222 million profit was booked.  The remaining open contracts represent about $4.2 billion of premiums received.  We also know these are European style contracts which means the holders cannot choose to exercise early.  In the case where some contracts were closed out early, it was noted in a filing that Berkshire agreed to close the trades out at the request of the counter party.

You can see in the performance chart above that all the indexes are higher than they were in the beginning of 2004, but have taken a pretty interesting route to get where we are today.  The table below sums up the performance of these positions by year along with the first two quarters of 2016.  Note the initial drawdown in 2008, but quick rebound in 2009.  This table includes a fair value assumption along with the intrinsic value of these contracts.  Buffett likes to include the intrinsic value when discussing these trades since they are European style contracts and cannot be exercised early.

Put PL

Source: Berkshire Hathaway Filings

The fair value of the options is determined using a Black Scholes calculation.  The implied volatility assumption for these positions was a weighted average of 21% which I find pretty reasonable considering the average for VIX has been around 18 for the first half of 2016.  The Euro Stoxx 50 and Nikkei 225 were under pressure during the second quarter which contributed to an increase in the fair and intrinsic value of these position.  As of June 30, the fair value was very close to $4.4 billion which results in an unrealized loss of about $10 million.  Based on the intrinsic value of the positions the trade is looking a little better with an unrealized profit of $2.42 billion.

One other thing we do know is that in four and a half years these contracts start to expire.  I’ve been focused on this trade for years and can’t wait for the contracts to be retired and profits (or losses) booked.  Once they are closed out I hope to back into these trades or even better hope the information we receives is a bit more forthcoming about The Buffet Put Trade.