ERICOPOLY

I think of options in a more fluid sense - I see it as managing likelihoods. 1. This still leaves you with the loss on BAC original position - if you sell your underlying position at that point. Selling the puts on WFC is an attempt to avoid having your protection move up and down in concert so if they do, it is more likely to be from Mr. Market and this presents an opportunity to sell profitable put position and buy more underlying. sure, I was just trying to reconcile the statement of "you can sleep at night knowing your loss is at most 7". To confirm, that sentence is missing "as long as WFC doesn't go down the same amount" I believe? This are my original words before you edited out the important part (now in bold): Now you can go to sleep at night knowing that the worst you can lose from your BAC position is about $2 per share.

twacowfca, If I want to write put options on something I would like to own at a lower price, and use the proceedings to invest somewhere else – for instance in something that I like as much, but I consider to be already at a price undervalued enough –, do you know a broker that works also in Italy and that will allow me to do so? I tried with both Banca Intesa and Unicredit, but I failed… They don’t let me do that on companies listed in stock exchanges outside Italy… Maybe it’s a silly question, because you don’t know anything about Italy, but you seem a master of the trade, so I try to ask you anyway. ;) It would surely be very nice to have some float I could work with! Thank you very much, giofranchi giofranchi,... you will definitely be able to write put options in real time with "Interactive Brokers" http://www.interactivebrokers.com/ibg/main.php http://www.interactivebrokers.com/en/ibglobal_sites.php They also have a multi-currency platform, thus... USD, EUR, CAD... you can have integrated sub-accounts in any currency with your main account. Interactive Brokers are worldwide leaders for option trading. And some board members mentioned that they are also customers. Hope this helps. Cheers! Thank you very much berkshiremystery! You are always very helpful! And I will check them out asap. Just one more question: Do you think they will let me write naked put options, or that they will ask me to cover them with cash? My idea of getting some float to invest doesn’t work, if I must put aside the cash to eventually buy shares at the strike price. Right? giofranchi Gio,... I just asked this question Eric,... because he seems to be with IB,... ::) so let's wait for his answer,... I'm as curious as you to know this.... ;) It does eat up margin capacity. In the event of a steep pullback you can always ditch the puts and common stock position and purchase calls. Lots of flexibility. Again, I'm hedging about 40% of my position, and some of that is actually in my RothIRA where there are no tax consequences. There, I own the common stock of something like WFC and write calls. I then use the call premium to offset the cost of the embedded put in the BAC calls and I collect the WFC dividend.

I just look at the strikes and the prices and then figure out what I want to do. Use WFC for example: http://finance.yahoo.com/q/op?s=WFC&m=2014-01 Supposing you want to hedge a $30,000 BAC position such that you don't want to accept any losses below $7 per share. 1) Write the $30 strike 2014 WFC put for what looks like about $3, which is 10% of notional. 2) Buy the $7 strike 2014 BAC put for what looks like about 11.5% of notional. Now you can go to sleep at night knowing that the worst you can lose from your BAC position is about $2 per share. Ok, so I was trying to follow your conversation with meiroy, but I think I failed. I'm just trying to get the mechanics of the above. First, are you fully hedging your whole position of BAC with the above? 1) If they both move up or down in concert, then they offset right? That still leaves you with the loss on BAC in your original position? 2) If BAC drops to 7 or lower, and WFC holds, you get your protection. 3) If WFC drops and BAC goes up, you lose? (except your main position has increased, but if you fully hedged, then you'd have a corresponding amount of WFC to deal with) On the, "you can go to sleep knowing the most you can lose is 2 dollars", bit, that's only true if they both don't go down a lot, no? i.e., if they both drop by half, you don't have any protection on your main BAC position since the other two offset each other? Never risk more than you can afford to lose. That is a true quote from my grandmother, who herself was a stock picker. I am hedging accordingly. Some of the BAC position is not hedged at all, just like those who are diversified. The part I cannot afford to lose is hedged. Yes, of course I take on the risk of WFC declining. In this regard it is the same as what everyone does when they claim to be diversifying their risks. That's just plain vanilla flavor, only it's not regular ice cream -- some kind of weird frozen yogurt.

I actually don't keep cash, I keep some part of the position hedged with puts -- I can sell the underlying stock and put and buy the corresponding strike call if I need to raise cash. This is a $4 strike put, doesn't cost all that much. In the meanwhile, I have a large margin borrowing capacity and just have an automatic monthly withdrawal setup to transfer to my checking account from IB.

No!!! I have otherwise 100% of my money in BAC. This isn't about guessing which company has a lower chance of dropping, this is about avoiding total armageddon in my portfolio if for some reason BAC goes towards zero. Like you, I prefer to spread the downside. Unlike you, I don't want to diversify the upside. And while I'm at it if BAC were to drop and WFC doesn't, I'll take advantage of that. Why the hell not? Or if I have tons of gains next year I can write off the loss on the BAC puts on the last trading day of the year and book the gain on the WFC puts on the first trading day of the following year. Those little potential extras are like "gift with purchase" goodies at the mall.

What on Earth are you talking about? You asked me what I'd do if the market crashed and I told you. Then you come back arguing that it is not in purpose with the trade. Huh? I just care about making money. I don't know that the market is going to crash, but when life hands me lemons I get thirsty for lemonade. I don't want to buy any calls in the first place. Look, if you buy BAC calls today then you'll potentially miss out on a nice dividend next year. And when the calls expire if you take delivery on the shares you can't deduct the cost of the calls from the taxable income on the WFC puts. One thing I might do is close one out on Dec 31st and the other on Jan 1st -- that's a nice little extra way to make a bit of money depending on whether next year is a big tax year or not (and whether I expect the following year to be). Rather than mess around with calls it is better to own the BAC common for the dividend, buy the BAC put that I presume will expire worthless, and write the WFC put which will have I presume a taxable gain that will be offset by the expiring BAC put. And like I said, if BAC drops back to $7 whereas WFC doesn't move much I can dump the BAC puts and buy more BAC common. Look at how WFC traded this summer vs BAC. That's a very real scenario and it boosts my earnings power if it happens (more shares). Yet if it doesn't happen and the market just goes up from here nothing bad comes of that either.

Oh, well then you aren't me. Because it costs a lot of money. BAC's derivatives book is a hell of a lot larger than WFC's. That's really the key concern I have where if the Europe shit hits the fan I'd be feeling better with some of my money in WFC. Maybe you've never had 100% of your downside in one stock before, but I can assure you that it gets less intimidating when the downside risk is spread around a bit.

Market crashes. WFC goes to 22 and BAC to 5. You get called on the WFC trade costing 8-3 =5 and on the BAC you can get 7-5-0.805=1.2 to a total loss of 5-1.2 = 3.8 per share in addition of course to the paper loss on the common. Did I get that right? I did not understand the importance of mentioning the percentage of notional. Don't be such a wussy :) I wouldn't even go into the stock market if all I was worred about is crashes. This strategy is for going to sleep at night if a possible zero is the reason people are avoiding BAC. Given my exposure to BAC, I have some protection in place but I financed it by taking on some WFC risk. Now, if what you suggest happens then I'll add some leverage -- probably ditch the WFC at $22 and buy some WFC deep-in-the-money calls (or deep-in-the-money BAC calls, depending).

Yes.

I just look at the strikes and the prices and then figure out what I want to do. Use WFC for example: http://finance.yahoo.com/q/op?s=WFC&m=2014-01 Supposing you want to hedge a $30,000 BAC position such that you don't want to accept any losses below $7 per share. 1) Write the $30 strike 2014 WFC put for what looks like about $3, which is 10% of notional. 2) Buy the $7 strike 2014 BAC put for what looks like about 11.5% of notional. Now you can go to sleep at night knowing that the worst you can lose from your BAC position is about $2 per share. Now... supposing BAC takes a dive to $7 a month from now but WFC doesn't. And further suppose you believe it's irrational diving. So now you can sell your BAC put for a profit and cover your WFC put perhaps for the same price you wrote it for. Now you can maybe afford to increase your BAC position (just common stock) by 10% using the profit from those puts. Stuff like this happens to me. I don't count on it, but I take it when it comes.

+1 Sure, just give me the $1,000 fee for the Option Investing Congress where I'll reveal the secret to turn all of your losing options trades into winning ones! Money back guaranteed! Okay, here it is for free: 1) Whenever you go to buy a put or call, write one instead. 2) Whenever you go to write a put or a call, buy one instead. I guarantee your success will turn around 180 degrees. No, I don't have any books to recommend.

Yes, this board has served as a tremendous asset. I learned about the integrity of Prem and his team from this swarm and the swarm alerted me of the options play in 2006 at nearly just the right time. Then the swarm continued to throw gold bones my way, with the constant updates on when the CDS portfolio was gaining in value while the market price of FFH burned -- my RothIRA doubled in the two days following the short selling ban in Sept 2008. Then I have to thank Cardboard immensely for clearly laying out how the FFH team had telegraphed their intentions to buy out ORH, after which I stacked ORH calls into my RothIRA -- my RothIRA jumped 50% on the first trading day of the buyout announcement. In a way the CDS gains and the ORH buyout were practically like trading on insider information, only this was perfectly legal.

Given that during my investing experience I've had these returns I therefore expect it to be like this forever. I remember you came out of nowhere with a condescending post about the "BAC cheering post". Is this another sucker punch?

I'm sort of hoping (a long shot) that somehow the bank splits itself into smaller pieces to get out from under the onerous 9% Tier 1 common capital rules. Wells Fargo is smaller and/or less risky (no Merrill Lynch) and only needs 8% Tier 1 common capital.

He praised the BAC franchise that existed in 2006. That part of BAC did just fine, leverage and all. Anyways, here is how I hope to dispose of my BAC. Hold it until they are paying a dividend yield of 60 cents a year -- begin to sell it when other large cap stalwards are paying a similar yield. This way I can preserve my earnings power while diversifying. The first 50% of BAC that I sell will be the easiest because it will be a tax-free transaction. The taxable portion will be harder, but I can always hedge it instead of selling it (by writing puts on other stalwarts and using the proceeds to hedge my BAC position).

Mike Mayo put a $2 in earnings power number on BAC last year and then just a few months later set a $7 price target on the stock (as you would expect he did the price target drop after the share price had dropped significantly). I suppose there is career risk involved in these decisions. Once the analysts get comfortable to stick out their necks again they'll remember the $2 in earnings power that they so quickly forgot.

In the past I've purchased companies that were HWIC, Berkshire, of Fairholme holdings. There is of course no guarantee that they'll do well, but they've passed the balance sheet sniff test. Those guys can catch any obvious balance sheet analysis red flag, so I figure why bother. I just then have to focus on the narrative. This protects me from making the basic entry level errors, which I'd surely suffer a lot of hurt from if I struck out solely on my own. Buffett is looking at long run earnings power, he looks at the balance sheet no doubt and at management because there is no sense investing for the long run earnings power if the company won't be around in the long run. That's one reason why I like his interest in BAC, even if it is via the preferreds -- he thinks in terms of not wanting to risk his opportunity cost, not just his capital invested..

Okay, but my personal 401k+IRA+RothIRA started out higher than $200k on the day I retired in January 2008 and today it is up to slightly more than 11x. I'm not going to mention the price starting figure in 2008 because I don't want to be too specific on divulging net worth. I've mentioned previously that roughly 50% of my net worth is in my RothIRA. So by stating that it started at 200k and is up 11x, I'm already conceding that my net worth must be at least $4.4m today. So supposing I hold a 100% notional position in BAC and the common stock price triples in 5 years. Then at that point it's only yet another triple from $40mm. And, of course, supposing I started out with more than $200k in my tax-advantaged accounts in early 2008... Not sure I followed all the suppositions, but I will say that if you in fact turned $200k to $2.2mm+ in less than 4 years I am very impressed and you are truly an outlier. As for continuing to invest in this manner and/or achieving similar returns, I wish you the best of luck and hope you can follow on those fantastic results! I will only say that from a purely economic stand point if you can achieve those results you should lever up your personal returns by starting a fund and commanding an incentive fee. I am fully aware that not everybody cares about being a fiduciary and/or dealing with all the bs that comes with managing other peoples money but I just think that having such an audited track record would do you wonders and supercharge your already incredible compounding machine! I don't want to be a professional money manager. I couldn't analyze most balance sheets to save my life. My technique is to recognize the people who do know how to do that and watch their holdings. Then if the holding fits my narrative I load up on it.

Okay, but my personal 401k+IRA+RothIRA started out higher than $200k on the day I retired in January 2008 and today it is up to slightly more than 11x. I'm not going to mention the price starting figure in 2008 because I don't want to be too specific on divulging net worth. I've mentioned previously that roughly 50% of my net worth is in my RothIRA. So by stating that it started at 200k and is up 11x, I'm already conceding that my net worth must be at least $4.4m today. So supposing I hold a 100% notional position in BAC and the common stock price triples in 5 years. Then at that point it's only yet another triple from $40mm. And, of course, supposing I started out with more than $200k in my tax-advantaged accounts in early 2008...

I am always surprised that such a large pool of intellectuals have such a difficult time grasping the difference between managing $50k or $50mm.. I have elaborated enough on this topic. For those that believe that you can replicate those returns I suggest you start your own funds maybe you will be in the next copy of Jack Schwagers market wizards! Ok, well I guess I missed the part where you explained it earlier, so I'll take it as a loss. In any event, I didn't say 50m, I said the difference between 50k and 500k. Certainly there is a huge difference between amounts of money that move a stock price or compete with volume and what not (e.g., professional managers such as yourself), but individual investors aren't at that level. For individuals, I think Eric's comment makes the most sense and is how I view my own tiers of situations. Regardless, in the other thread, you indicated 300k was a "decent amount of capital", so perhaps I'm just not understanding what you mean? Starting with $50m, one could set aside $10m in BRK and risk the other $40m. Life would hardly be handouts and jobs at taco stands if the $40m went to zero. Perhaps soon we'll get to a point where the large cap financials don't trade at such low valuations -- perhaps then it will be exceedingly difficult to earn large returns on $40m invested.

It is also easier to take on concentrated risk when you have a large portfolio. There is some kind of concept analogous to the Laffer Curve at work here. A) When the portfolio is itty bitty relative to your rate of savings, then you can have a lot of risk and have it not be that risky. B) When you have tons more invested than person "A" has, yet the amount you have is barely enough to retire on (and you then go ahead and retire), then you cannot take on much risk at all because C) When you have 3x as much money as you need to retire on (you are triple rich compared to person "B", and you are still young anyhow (I'm 39), then you can afford a goodly amount of risk. So "the bigger the line you swing in the market" beyond a certain point, the easier it is to sleep with risky positions.

Buffett also said that he was going to retire after he had a few million (maybe $10 million?) back in the day, too. ;) You got a knack for investing, eric. I've learned a ton from you and I'm very thankful that you're on the board (even if you are an unmoral, dirty atheist!). :) Well he also said a long string of good results followed by a zero is still a zero. That's where I'm coming from, because after all I'm not Warren.

Nice. How much of your portfolio is still BAC exposure, if you don't mind me asking? I think it's about 60% of net worth downside exposure to BAC in the event of $0 BAC stock price. It's a complicated setup though -- I have more than 100% notional in-the-money in BAC at the moment.

Sometimes I will write a put and use the proceeds to purchase calls. Like say for example I want to go long 100% notional BAC but I'm worried about systemic risk in the global banking system originating from a potential disaster with the Eurozone periphery states. I can: 1) write puts on something else and collect "the proceeds" upfront 2) use "the proceeds" to either buy calls on BAC or purchase puts on BAC This is a "Frankenfolio". I might have 100% upside BAC but with 0% downside of BAC. This is what options markets are designed for -- swapping risk with others.

It's not skill, it's risk tolerance. Like I've said, after BAC works out I'm done. This is my last big gamble. Then I'm going to hold a big chunk of BRK or FFH and the numbers will no longer be volatile.