This morning, the WSJ reported that Warren Buffett has been on an aggressive buying spree during this bear market. There is a link to the market below. Buffett has been buying value stocks such as Chevron, Occidental Petroleum, and Hewlett-Packard to name a few. When he is buying on the stocks, he isn’t predicting that the market has bottomed, but instead he is taking a long-term perspective, and is buying securities that trade at discounts to his estimates of intrinsic value. This unemotional and disciplined process is what has served him well over the last six decades.
It doesn’t get talked about a lot in the media, but Buffett has also used the selling of cash-secured put options to acquire stocks at cheaper prices, or generate an attractive return on the options expiring. Notably, he did this on the purchase of Burlington Northern Santa Fe, among others. When we are selling cash-secured puts, we are saying that we are happy to own a specific stock at a certain price. For being willing to take ownership, we are paid a premium, almost like an insurance contract. Most options don’t actually get exercised until close to expiration, but if we do end up getting exercised, we have all the upside or downside on the stock from the strike price of the options, minus the premium collected. Therefore if we sold a $10 LC January put option for $1.50, our breakeven is $8.50 per share.
When volatility is extremely high as it has been this year, that option price that was $1.50, might double to $3.00, showing a short-term loss, but the only thing that matters is where the stock price is at expiration. At any price above $10, we make 100% of the profit, which in this example would be nearly 18%. If the stock is below $10, we will have bought the stock at a breakeven of $8.50 and will have the upside from there. The volatility and time factors that play a big role in pricing prior to expiration will be completely irrelevant, which is why I never suggest getting too caught up in short-term mark to market fluctuations, particularly with an options portfolio. The reality is that these strategies provide massive protection from markets such as this, which will ultimately be realized over the fullness of time.
The markets have come down a lot and valuations are a lot better than they were to start the year. No doubt, the economic and macro pictures are worse, but markets price in the future. Returns have usually been very good when we’ve been in similar situations. With that said, I wouldn’t be shocked at all if the market dropped another 10-15% either. Those things do happen, but I’m also confident that we can handle it and still be in good shape when all is said and done, or if the market has bottomed, we would certainly reap the benefits of that as well.
Two of my favorite Buffett quotes are the following:
“You pay a rich price for a cheery consensus.”
“If you wait for the robins, spring will be over.”
Don’t get too caught up in the news or headlines, which are meant to sensationalize you to keep you glued to their shows. Remember what your goals are and why we use a disciplined process to really give us the best opportunity to only be buying securities at large discounts to intrinsic value. The key is staying in the game and not being greedy or paralyzed with fear. These are times where we are planting seeds that should be richly harvested at a later date. Below is the article.