ERICOPOLY

What's stopping him from buying more then? You don't think he's buying enough? Here are the number of Sears shares he's held in his 13Fs.... 11/2013 20,758,173 8/2013 20,392,973 5/2013 19,508,773 2/2013 18,146,573 11/2012 16,934,080 8/2012 16,829,880 5/2012 16,813,480 2/2012 16,108,492 I would be shocked if his 13G/A that he files on 2/14 doesn't show that he bought a bunch more of SHLD. I am fascinated by SHLD, but definitely do not have the same level of conviction as Bruce. The Fairholme Fund grew in asset size over the last two years. He holds 25% more shares today versus two years ago. Has his Sears position as % of net assets in the fund been getting larger or smaller over these past two years? In other words, let's say his fund grew 100x in size and over that time he bought 25% more SHLD. That wouldn't be too impressive. So I know Fairholme didn't grow 100x in asset size, but did it grow more than 25% over the past two years? It wouldn't be all that bullish if it were getting smaller as a % of the fund. It depends on whether the fund is growing faster than his SHLD position.

What's stopping him from buying more then? The net assets aren't generating the return they deserve, so you have to discount them. Perhaps he is doing that and arrives at a number that isn't sufficient to justify an increase in his position size.

It is also interesting to me why Eddie is hoarding 1.8b of cash now. Is it because he's going to do a big settlement with the pension, once for all? But I highly doubt the reason is that he will all of sudden start to use it to invest in other stocks. He did not do it in the past 4 years. Why start to do it now at the market top? There is really not many bargains out there ... (one of the reasons I am forced to look at SHLD. :D ) Well, let's say he buys a new business. Hopefully it's something that is rapidly expanding, so that he solves another of his problems at the same time (finding a tenant for his real estate). Here is an example of an expanding business that needs new locations: http://www.traderjoes.com/stores/store-calendar.asp They have 5 stores opening this month alone!

Hey, don't feel bad about owning Citi today. At least you didn't own Berkshire (down slightly more than Citi). MBI did great though. Some analyst mentioned that Puerto Rico downgrade won't be so bad.

It sold for about 10x earnings in 2006/2007. I remember this well because Bill Miller was spotlighted in a Morningstar article/interview where he was saying that if he wanted to own a commodity, it would be "C". Commodities at the time were hot and he thought he was clever buying C because of the low P/E. Banks like C and BAC today achieve their earnings with far less risk compared to then, and consequently I think there should be a risk/adjusted increase in the market P/E for the same dollar of earnings. The market will value banks based on earnings, not book values, and they will assign a P/E based on what amount of risk achieves those earnings. So far the biggest risk I've seen for a bank is the dilution risk (that is, if they can even raise capital -- I'm talking about the risks to the banks that don't completely go under) -- most of the hit to C and BAC's stock price since 2007 has come from dilution, not loan losses (helped by the fact that "bailouts"/intervention let them survive). So now that they hold a lot more capital (and they are forced to do so by the regulators), that risk is massively reduced. Needless to say, their funding models are also much cleaner (greater reliance on deposits instead of wholesale funding and LT debt). And risk has been reduced in many other ways (better terms on loans, better collateral backing RE loans). Nobody can argue that $1 of earnings achieved in a high risk manner will get the same market multiple as $1 of earnings achieved in a relatively far less risky manner.

It's not clear to me which one is better. There are scenarios where one way is better than the other, and vice versa. I had a greater bias to one scenario over the other ten months ago when the stock was at $12. It does seem clear to me though that as the company accrues earnings, settles liabilities, runs off bad loans, grows earnings, etc... etc.. etc... The $15 put is more likely to be in the money over the shorter term than over the very long term. You'll get another $2 of cash earnings throughout 2015 -- likely only a minority portion of that will be returned via dividends throughout the 2015 year. So one thought I've been entertaining is that perhaps a $15 strike put for 2015 is the rough risk-adjusted equivalent of a $14 strike put for 2016, and perhaps a $13 strike put for 2017. Unfortunately though, they are not offering a $14 strike put for 2016. Not yet anyway. This isn't advice, but have you looked into writing covered calls as a way to reduce your time premium risk? The only one I see incredibly unlikely to be breached is the $30 strike call. It traded for 30 cents today. Of course, if you are thinking of selling the stock after a quick pop that would prove to be a mistake (you'd be likely buying it back for a loss), but if you intend to hold the position until maturity for tax reasons (like me), then perhaps it's not so stupid -- after all, it reduces the net risk I've exposed myself to from option premium decay. I could take that money and buy back some of the puts that I've written on other names, for example.

Single-issue downside risk is what I'm trying to limit. An example: Fairfax restatement of financials in July 2006 due to mistakes they made in currency translations (who would have expected that???). I like concentration in the banks right now. Some don't, I do.

The original inspiration for the construction of this BAC portfolio was when I held the class "A" warrants a year ago. The warrants have this feature where they give you credit for the dividend, but it is a non-cash dividend. However, the IRS taxes it the same way as it taxes cash dividends. So you have this decaying put premium embedded within the warrant, but you can only implicitly deduct it from your capital gain when you go to sell the warrant. All the years along the way, you have to pay this dividend tax -- and the tax rate on that goes up to about 33% in California. So I decided to reconstruct the warrant using the common stock with portfolio margin and puts. Then, I can deduct the puts every year and not get the dividend tax. I can play games, like take a tax loss on the last day of this year on my expiring BAC puts, and defer the gains on my JPM,C,SHLD puts until the very next trading day (the next tax year). So by doing this I can move a tax bill out to a future year. Plus I can move the strike price up on the puts, as I recently did (moving from $12 up to $15 strike). That's something you can't do with the warrants. So anyways, it's very very very very helpful I have found to really deconstruct all of this stuff. You really get intimate with the risk so you don't wind up with that head-in-the-sand cognitive bias I mentioned (where you treat highly leveraged positions the same as if they weren't, and where you make the second mistake of not counting up all the time decay you expose yourself to on a net basis). IMO, I benefit from keeping my eyes open to exposures -- the risks.

It's raining here, in Santa Barbara, despite the drought. This is a sign that the Seahawks are going to carry the day.

Whoa. Who did you choose to manage your Roth? Roughly 30% with Sanjeev&Alnesh (MPIC). The rest I decline to say.

Buy Trader Joe's and roll out new stores into a big chunk of the SHLD real estate across the country.

It's worthwhile to think the IRA strategy through to it's final conclusion. (if you are really successful compounding it )-- you wind up just racking up too much of an estate tax liability once you reach a certain point, even though it is meant to be "tax free" in the Roth. I hit that point recently and then (after it fell back 10%) I decided that it would just go back up to that level soon enough and I may as well just stop trying to grow it myself. So I turned it over to the pros. I don't manage the Roth anymore (as of two weeks ago). I still expect it to rack up this tax liability higher over time, but I think the management of it is now lower risk -- and since I can't keep as much of the gains, I think the risks should be lower as well. Plus, this is lower stress for me -- a lot lower! I can instead give money to my kids through a tax-advantaged indexing strategy (like a variable-annuity held in a Crummy trust). Their eventual taxable gains on that will likely be lower than today's inheritance tax rates (which I assume to not go down with time). However, I still haven't established any such trust for them. Not sure if I will... just pointing out that from a tax standpoint, the Roth probably no longer has an advantage over the Crummy trust approach when you take into account the inheritance taxes and assume a low-risk indexing strategy.

Isnt that obvious? Like what happened in Volkswagen. A margin call could turn a 5% exposure shorting Volkswagen into a 100% loss on the whole account. Personally I never use leverage/margin so its simple for me. I also don't think the person who started the thread was thinking about weighting using leverage. Damn right it's obvious that portfolio weightings need to be expressed while taking notional leverage into account. You either have notional leverage, or you don't. The Mohnish system is for unleveraged -- add some leverage through derivatives, and it changes things.

You could have 10 positions (BAC calls, GM calls, KO calls)... etc... where each is at-the-money calls. You actually have a 100% loss potential from the passage of time alone (until expiry). So you need some sort of framework to think about option position sizes if you hold options. I don't think you can use the same rules as you use with common stock. My framework is to think about how much net time decay exposure I have (netting out premiums on options I've purchased against premiums on options I've written). Then I further think about (if I'm dealing with in-the-money calls) how much leverage I have to the downside price movement in the underlying stock. Suppose I have 2x leverage in deep-in-the-money calls -- I think of that more in terms of a 20% position sizing rather than a 10% position sizing. Otherwise, I'd fool myself into believing the position is smaller than it really is (you quickly realize the mistake if the stock drops and your losses look and feel like they are twice as deep compared to the unleveraged common). Now, if you want to grin a bit from the irony of it all, somebody else on this thread urgently wants you to think about it as only 10% exposure (so that you don't suffer unknown/unexpected risk from a complexity-induced bias! LOL, his approach leads to a "simplicity-induced" cognitive bias for the reason mentioned in the second sentence of this paragraph ;)). You don't blindly take rules designed for uncomplicated things (unleveraged strategies) and apply them to complicated things (leveraged strategies).

I don't get why weightings is complicated. Out of 100% of your portfolio how much are you allocating for each security? What has weighting of security in a portfolio got to do with capital at risk? From your example. I can have 10% in SHLD and 10% in BAC and that's my weighting. You can have 10% in SHLD/BAC + Puts at 26% or 10% of strike so your weighting is 12.6% for SHLD and 11% for BAC. My risk for both is I can lose 100% and your risk is you lose 26% and 11% so what. The question asked by the person who started this thread was "How you weight your holdings" ? 1. Equal weight like Mohnish Pabrai 2. Weight by relative Value or upside like Bruce Berkowitz 3. Weight by sector The first option is "equal weight like Mohnish Pabrai". I think you'll find that he doesn't purchase short-term call options in his funds (including LEAPS, although he was able to purchase GM warrants in one of his funds). He has this 10% weighting in order to be able to limit single issue risk. So you are cheating the system if you hike up the single-issue risk by purchasing calls. You still have 10% max exposure, but a much higher amount of risk on that 10%. It's not really the same thing at all as what Mohnish is practicing. You may think you are playing within his framework of rules on position sizing, but not really. You need to go back and think about why position sizing exists in the first place. It could be a system of risk management (for the downside). Right? So doesn't the position sizing change when you use derivatives to hike the risk through the roof? This is why I'm encouraging you to think of position sizing in terms of upside/downside exposure. Look through the derivative and see what it represents on the underlying side. I'm talking about unleveraged downside, so that it's apples-to-apples comparison with the type of unleveraged downside that Mohnish it talking about. You have to ignore another person on this thread who is pleading with you to treat a derivative like it were common stock when you choose position size. You can't just refuse to think about the look-through leverage (and the premiums/costs you pay for it) under the banner of avoiding complexity. The complexity is already there unless you have a rule not to own derivatives -- once the derivative is owned, you don't reduce it's complexity through refusing to think about it. It takes a bias to believe that ignoring something makes it go away -- a false sense of absence of complexity (out of mind, out of reality?). So let's say you have at-the-money position size of 10% in call options. You can lose the entire 10% from time-decay alone! Now, are there other places in the portfolio where you'll have an offsetting profit from time-decay? That's what I'm doing -- I'm netting out my future time-decay risk (I purchased premiums, and I sold premiums), and then asking myself on a net basis, how much time decay exposure do I have?

I don`t think that a bank would be allowed to do what Eric is doing. When you look at the risk profile Eric has just a big LEAP call position in BAC and is long in JPM,C and SHLD. If this risk profile is further levered up or not does he only know himself, but from what i read its further levered up. So when a 100% stock portfolio will suffer a 50% drawdown he is on the edge of losing everything. I don`t think that is something worth copying, especially with this combination of securities. Let argentina blow up and he is probably in trouble. But as always thats my understanding of his situation, i can be wrong. :) The BAC puts are $15 strike. As the stock drops below that point, the portfolio is no longer leveraged to the downside. I no longer feel any additional pain from BAC dropping at that point -- instead, the only further pain I can experience is from the amount of notional exposure I write on the other names. It works like this... First, I figure out how much I have left when BAC drops to $15. Second, I restrict the notional amounts of C/JPM/SHLD puts that I write to that "$15 is worst case" BAC scenario. There is no chance of total wipeout from the leverage itself. A "magnified drop", let's call it. So let's say I have 2x leveraged BAC common position (notional value is 2x the value of the portfolio). Okay, so at $15 I've lost approximately 20% of account value instead of 10%. All I can say to that is "big fucking deal". I can live with a 10% permanent loss.

I'll decide what path to follow when we get there. I expect to get around a 3% dividend yield, which will take out a nice chunk of the margin costs. Then there is the potential to write covered calls. Initially the boost from higher short term rates will positively impact the bank earnings, and with it I expect the stock price. That will have an (at least partially) offsetting positive impact on the cost of rolling puts.

I agree. It just is what it is. Perhaps there is a cognitive bias but it's not coming from me? Richard said a few things above that cast a "very bad thing" characterization about "introducing complexity". Compare that to when Rabbitisrich dispassionately describes it in the terms of the actual economic position of the portfolio.

Nobody said or implied that you don't understand any part of this. That said, you've made my point and my goal isn't to convince you of anything -- I've read almost every post on this board for 12 years and I think nobody's done that before. You've read my posts, but you haven't understood what I am saying. Every time you argue "against" me, you are setting up straw men that you knock down. Then you arrogantly claim that you have defeated me and that I have not offered you a rebuttal. The problem is, of course, that you are not arguing with me, but rather with your straw man. Another quality misrepresentation Richard! I am used to this from you by now. The truth is that, I present it very humbly, the complete opposite of any sort of "breakthrough". I claim it to be nothing special at all, nor do I claim it to be "good" in any moral sense, just using derivatives for what they were originally designed for, the swapping of risk. In my own words, where I explicitly downplay it as any sort of "breakthrough": Nice! I "misunderstand" what I am doing when I use derivatives for swapping risk! Of course, that's just another of your assertions, claiming that out in the field my use of derivatives is causing me to suffer cognitive biases and therefore I misunderstand what I am doing. You have absolutely no clue if that's true! None! Just another of your assertions you pull out of thin air and then attribute to me. Yet you arrogantly present it to be the case, with no cause to say so. That's good timing in fact because you just said the following: There you go. When somebody misrepresents me, I'm being "refuted". I am the one who can clearly see when the things you say do not match up with the things I understand and believe. However, you don't expect me to realize that! How arrogant is all I can say.

I believe if I talked about the great, inexpensive campout I had with the kids, roasting marshmallows over an open fire, you guys would first state that I don't understand the risks of a campfire, and from there expound on the cognitive bias I am suffering from. Of course, the fact that I mentioned "FIRE" in the story would be overlooked and soon you would be warning me that campfires are hot, that they contain a fire, that a fire can spread, that my bias is causing me to overlook this danger, etc.. etc.. etc.. etc.. I'm then sitting here wondering... do these guys really believe I am totally unaware of this? When did I tell them that I thought fires could not spread, that they were not hot, etc.. etc... After all, I roasted something in the fire.

Yep, but let me ask you something. Where in the hell are you getting the notion that I don't understand any part of that? The BAC idea "standalone" is the same as one where you hold the BAC common, then write a BAC call, then buy the BAC call back. The legs are there, implicitly. You have that cash from writing the covered call, and from there you can choose what upside you want to hold. Perhaps you choose to hold the BAC upside -- fair enough. It doesn't add any new "legs" if you choose to invest it in the calls of a different company instead. There were already legs, you've just swapped them for different legs. There is still risk, you've merely traded your risk for some other trader's risk. This is why I call it "swapping risk back and forth". This is merely a method of diversifying the risk of a concentrated position. You can initiate a 10% position in the common of 10 different companies. You are familiar with that of course as a tactic of reducing single-issue risk -- it's called diversification of course (your downside in any single issue is only 10%). So I can utilize this time-tested approach of diversifying the downside -- meanwhile selling the upside (covered calls) in all those names and using the proceeds to purchase the upside just on one name. So I can achieve 100% concentration without ANY downside concentration. It's diversified across all the names I swapped risk with. There is no concentration on the downside. So given that this is a topic about position sizing, I am claiming that you don't have to worry about your position sizing on the upside -- you just have to find enough diversification on the downside. You can start first by: 1) building the diversified portfolio of common 2) writing covered calls on each 3) using the proceeds to purchase a concentrated position in your top pick Or do it the tax-preferred way that I mentioned -- buying the concentrated position in the common, and then writing puts on other names to pay for the puts on the concentrated name. Well, excuse me if I say... and no personal offense to you... "no SHIT Sherlock!". That's just a colorful phrase that I find humorous and I don't mean any disrespect. Didn't I make myself clear enough when I said I'm taking the upside of BAC and the downside of others (C, JPM, SHLD)? Or perhaps it wasn't clear when I talked about the COST of non-recourse leverage? Or that I'm deducting an expense (the depreciating puts). And the margin interest?

Continuing to misrepresent what I am saying does not make it true. You did the same thing the last time you argued with me. You are effectively arguing something that implies a common stock holder is getting a "free option". This however is not what I am arguing. So if the assertion is wrong, then I'm not the one who is wrong (because it's not my assertion). You are just claiming it to be mine -- you are just pulling the assertion out of thin air. Example: A person with two accounts buys straight BAC common in one account (the first of two accounts). He then writes a covered call in the first account where he holds the BAC common. Then he takes the proceeds from writing the covered call and moves this cash to the second account. In that second account, he has the choice of investing that cash in absolutely anything. He can buy SHLD calls, JPM calls... anything. But he instead purchases BAC calls. Does this imply that he is getting a free option on BAC? Is this what you call "Zero Sum" bias, because the decay from one will offset the decay from the other? So do all common stock holders (who don't trade options) then implicitly suffer from what you call "Zero Sum" bias? Logically, his position is no different from just being in the straight common at this point. So does this mean that anyone with straight vanilla common is getting a "free option"? After all, you preached about decoupling. Once you start down that decoupling path, the cash in the second account has been decoupled from the first account. So your argument is such that the upside in BAC is claimed to be "free". This is a false assertion because anyone can clearly see that it's not "free" at all. You are just barking up the wrong tree.

Do you agree that $10/$17 is the same fraction (roughly) as $17/$29? Well, it is roughly the same. Okay then, you said the $10 strike put costs 1% today. Just wait... the $17 strike put will cost perhaps 1% once the stock hits $29. So in the first years, you don't see the gains from this leverage. However, it's like an adjustable-rate non-recourse loan -- in the later years (stock price is much higher), the cost of the $17 strike put keeps dropping. So it's one of those things where you are rewarded for your patience. The strategy works best when you have an undervalued stock that will not take too many years to rise. This BAC common was last purchased in March 2013 when I dumped the warrants and moved to the common (purchased at $12) hedged by $12 strike puts (which were at-the-money then). It cost about 11% at the time (just like now) for at-the-money put. But how much does it cost for a $12 strike put today? Not even a year later. :D :D :D So, adjustable rate non-recourse margin loan -- only the terms get cheaper and cheaper as the stock rises. I chose to lock in much of that gain by hiking the strike up to $15 (rather than continuing at $12). However, after locking in gain, even the $15 strikes are now cheaper than the $12s were back in March.

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better. ;D Yeah, I wouldn't want to quote WB either on this topic -- because he has 99% in one stock! Just one! But seriously, that's why I have the puts. It doesn't matter how much notional upside you have -- it just matters your notional downside positioning. I think having 100% notional upside is just fine -- no Black Swan can wipe you out. Black Swans only hurt your notional downside exposure. Perhaps i am not up to date, do you have your complete portfolio hedged with puts or only the margin part? When you have your complete portfolio hedged with puts than make a profit graph where you see where the stock has to move to profit and then overlay that with a standard distribution of price movements and you will see that you have a <50% chance of winning and your hurdle rate to profit is relative high. This only works when the stock market is booming like last year. In a normal or sideway year you will lose money even when the stock does not move. You are fighting against the mathematics here simply because you are paying an "insurance" premium and implied volatility is nearly always higher than realised volatility. (There are scientific studies on that theme.) When you only do it for the margin part, then probably its cheaper to just buy calls on margin because you save the interest costs for the additional capital. And i don`t think you can make up that interest cost with tax savings through additional compounding when you don`t plan to hold longer than 5 years. (Its hard to plan so far into the future when you are buying on margin.) And one additional example for the S&P500. When future market returns are prospected to 6-7% and your puts are costing 5% of your returns you are essentially earning the risk free rate and nothing more. (the free lunch here is earned by the market makers and option sellers.) I have a $15 strike BAC put for every BAC common share that I own. Then I've written some puts on JPM, C, and SHLD. This has the effect of dampening single company risk and reducing total notional downside exposure. Implicitly I hold a lot of cash that I can withdraw even during a situation where all these stocks go to zero). However, in actual fact, I have a lot of margin debt. Despite having less than 100% downside exposure, I have a lot of margin debt. I think if you watch what people do in real estate, you'll get a bit of a hint of why I'm doing this -- they call it "negative gearing" in Australia where you have a position that creates a net taxable loss, but the appreciation from the assets (that you never sell) give you a gain that you can borrow from. The puts make the margin loan non-recourse debt. I will probably not sell the BAC shares -- once they get up to mid-twenties, I will just roll the puts up to at-the-money strikes and continue to hold. Then purchase new investments with the margin borrowing power. The margin debt at that time will once again be non-recourse (from the at-the-money strikes on BAC).

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better. ;D Yeah, I wouldn't want to quote WB either on this topic -- because he has 99% in one stock! Just one! But seriously, that's why I have the puts. It doesn't matter how much notional upside you have -- it just matters your notional downside positioning. I think having 100% notional upside is just fine -- no Black Swan can wipe you out. Black Swans only hurt your notional downside exposure.