Making 50% per year like Buffett (on small sums)

[benhacker]

The 50% topic is always interesting.  At $100,000, I beleive, at $1m, it would be hard, but I've seen enough to think it could be done.  Here are some areas where I think you could get the kind of annualized returns *and* you could probably find enough ideas to occupy $1m in capital (maybe)

 

1) Workouts / Liquidations - there are tons of liquidations out there, not my area of expertise, but I know some who hunt this space.  The highlight for me was watching someone make ~100% in two days on a liquidation situation where the ex-dividend dates were confused.  This was not a normal situation, and it required threatening legal action against an iBank and calling FINRA, but it happened and I watched it in real time (don't ask the stock or more details as I don't want to share) although *I* didn't make the money.  :(  This particular trade was good for on the order of ~$50k though.... and making 6-10% in a month or two is possible in many workouts, but you have to keep finding more to occupy a real portfolio.  Not my area of expertise, but I've seen it done.

 

2) FDIC / SEC disclosure mismatch - There are situations where FDIC bank reports get released before holdco SEC filings... creating a window of opportunity for enterprising investors.

 

3) Reverse mergers, going private - This was mentioned above.  Lots of ways to make 5+% in a few names in maybe a month but only on "tiny" dollar amounts.... this was ripe right about SarbOx but is still around today.

 

4) Others I'm sure.

 

I think a better way to talk about the 50% commetn is to ask yourself is Buffett's skill worth $500k in the small cap world for a year of work?  I think yes... sounds better as $500k than 505.

[netnet]

One of the reasons I started this thread was to get more ideas about where to look.  Thanks BenHacker for the FDIC SEC mismatch.  I smacked my head on reading that because I have actually gone through FDIC filings, so I should have thought about the mismatch.

 

On generating ideas--where do people find the best arbitrage and liquidations.  I do a periodic news search, with liquidation, spinoff as the search term;  this is a bit tedious,which is okay, but it is not particularly efficient.

 

Think about this for a minute.  If one could do this over 10 years one would grow from 100 k to 5.6 M; another 10 years and 332 M.

 

It is not doable.  No one has a public record of success picking stocks like this.

 

Sorry, but to paraphrase Taleb, saying there is no black swan does not mean no such exists. In this case the "swan" is compounding small amounts of money, and small amount is a crucial part of the point.   It is unlikely and hard to compound at that rate but not impossible.  Apparently we have our own Ericopoly as evidence.  Furthermore, the point was that above a certain amount say 10m, most agree that it goes from improbable to well nigh impossible.

[ERICOPOLY]

Eric, that is f**kin awesome! Talk about running hot! I still remember the FFH options talk from the MSN board. I also remember dengyu and I miss his contributions.

 

I first dengyu at Microsoft -- they have an "Investment Club" distribution list there.  I would post there, and he would post sometimes as well.  We started chatting back and forth in email as our investment style seemed to be similar.  That was April 2006, and I mentioned Fairfax and the old MSN Berkshire board to him.  That's when he showed up on that board, and it's right around the time when FFH options got really cheap.  He suggested to me that I should look into the options -- before that I'd never even worked out how puts/calls work.  I would still be wearing an employee badge if it wasn't for him walking me through it.  We would buy some nearly every day and swap stories of what prices we got.  I remember getting an email from him one day stating that at closing he got 50 contracts of the $160 strike 2008 for 80 cents.  Just imagine... the stock broke $300 before that expired.  I had written a jscript file that would compute how much money I would make from my FFH calls at various prices (I had 240 contracts).  We were both supremely confident that we could retire on that trade (he quit at age 25 before the end of 2006, having worked less than 2 yrs).  So the week he quit, we decided to meet in person and went out to lunch.  Pretty funny sitting across the table from someone I'd never seen in person, and here we were both able to quit... and all for a trade that seemed to us highly predictable.  Just laughing and grinning.  Good times.  I stayed on until January 2008, it was harder to let go for me because I'd been "institutionalized" (quoting The Shawshank Redemption after 10 years of being there.  Today he's developing games on his own time -- good for him.

 

 

 

[leftcoast]

Eric, that is f**kin awesome! Talk about running hot! I still remember the FFH options talk from the MSN board. I also remember dengyu and I miss his contributions.

 

I first dengyu at Microsoft -- they have an "Investment Club" distribution list there.  I would post there, and he would post sometimes as well.  We started chatting back and forth in email as our investment style seemed to be similar.  That was April 2006, and I mentioned Fairfax and the old MSN Berkshire board to him.  That's when he showed up on that board, and it's right around the time when FFH options got really cheap.  He suggested to me that I should look into the options -- before that I'd never even worked out how puts/calls work.  I would still be wearing an employee badge if it wasn't for him walking me through it.  We would buy some nearly every day and swap stories of what prices we got.  I remember getting an email from him one day stating that at closing he got 50 contracts of the $160 strike 2008 for 80 cents.  Just imagine... the stock broke $300 before that expired.  I had written a jscript file that would compute how much money I would make from my FFH calls at various prices (I had 240 contracts).  We were both supremely confident that we could retire on that trade (he quit at age 25 before the end of 2006, having worked less than 2 yrs).  So the week he quit, we decided to meet in person and went out to lunch.  Pretty funny sitting across the table from someone I'd never seen in person, and here we were both able to quit... and all for a trade that seemed to us highly predictable.  Just laughing and grinning.  Good times.  I stayed on until January 2008, it was harder to let go for me because I'd been "institutionalized" (quoting The Shawshank Redemption after 10 years of being there.  Today he's developing games on his own time -- good for him.

 

 

That's a great story! I'm at Microsoft now... making games on their time.  :)  I wonder if that investment club is still around.

[jb85]

does anyone know what the call options prices were like for WFC when it was trading around $10 in march 2009? 

[twacowfca]

does anyone know what the call options prices were like for WFC when it was trading around $10 in march 2009?  

 

The implied volatility on all options was sky high then as it was when the market crashed the previous fall.  The VIX reached record hights both times and stayed at sky high numbers for a very long time, wiping out many traders who expected premiums paid for options to quickly regress toward the mean as usually happens.

[jb85]

I should have clarified, specifically i was wondering about the call options with expire dates 1.5 to 2 years out.  I'm still learning about options, and the only ones i would really consider would be the longer time table options...even then it would have to be great odds.  Something like ericopoly said...20 to 40X payout if stock reaches atleast 80% of my fair value estimate within 18 - 24 months.

 

I imagine those type of odds were only available when wfc was below $13 a share for a few days (they may never have reached those odds) but i was just curious anyways

 

This is just a guess scenario but imagine WFC was trading at 13, strike price of 23, 18 month call options available for around  40 cents might be somewhat interesting.  but even then nowhere near the odds that FFH was at in 2006.

[Myth465]

This guy is obviously doing something right. 40% for 17 years, no leverage.

 

http://www.gurufocus.com/news.php?id=107953

[nodnub]

I should have clarified, specifically i was wondering about the call options with expire dates 1.5 to 2 years out.  I'm still learning about options, and the only ones i would really consider would be the longer time table options...even then it would have to be great odds.  Something like ericopoly said...20 to 40X payout if stock reaches atleast 80% of my fair value estimate within 18 - 24 months.

I imagine those type of odds were only available when wfc was below $13 a share for a few days (they may never have reached those odds) but i was just curious anyways

 

This is just a guess scenario but imagine WFC was trading at 13, strike price of 23, 18 month call options available for around  40 cents might be somewhat interesting.  but even then nowhere near the odds that FFH was at in 2006.

 

jb85, I was looking at the WFC options on those days in early march 2009.  I don't believe the WFC options ever reached odds as favourable as FFH options in 2006.

 

Back in 2006, I think we suspected that the FFH options became really cheap because hedge funds that had trouble locating a borrow to go short... instead they went and created short positions via options which distorted the option market for FFH. Ericopoly might chime in with a more accurate recollection.

[netnet]

We would buy some nearly every day and swap stories of what prices we got.  I remember getting an email from him one day stating that at closing he got 50 contracts of the $160 strike 2008 for 80 cents.  Just imagine... the stock broke $300 before that expired.

 

That was a great trade.  Now here is a question, even with hindsight.  What have been a reasonable amount of one's portfolio to put in the trade.  Given that the position could have gone to zero.

 

Personally, I would think it would be 0.5 to a 1% position, maybe 2%.  I just can't see putting more than that in options.

 

Thoughts?

[twacowfca]

I should have clarified, specifically i was wondering about the call options with expire dates 1.5 to 2 years out.  I'm still learning about options, and the only ones i would really consider would be the longer time table options...even then it would have to be great odds.  Something like ericopoly said...20 to 40X payout if stock reaches atleast 80% of my fair value estimate within 18 - 24 months.

I imagine those type of odds were only available when wfc was below $13 a share for a few days (they may never have reached those odds) but i was just curious anyways

 

This is just a guess scenario but imagine WFC was trading at 13, strike price of 23, 18 month call options available for around  40 cents might be somewhat interesting.  but even then nowhere near the odds that FFH was at in 2006.

 

jb85, I was looking at the WFC options on those days in early march 2009.  I don't believe the WFC options ever reached odds as favourable as FFH options in 2006.

 

Back in 2006, I think we suspected that the FFH options became really cheap because hedge funds that had trouble locating a borrow to go short... instead they went and created short positions via options which distorted the option market for FFH. Ericopoly might chime in with a more accurate recollection.

 

That's entirely correct.  The short sellers were financing their trade by selling out of the money calls in a big way. This drove down the prices of the calls.  A huge skew developed between the prices of puts and calls.  Calls were selling for a small fraction of the prices of corresponding puts.  When FFH got down to about $90,  to $100, we bought calls that expired in a few weeks that were about 15% to20% out of the money for a price of something like $0.80. The price kept jumping; half an hour later we paid something like $1.20. When the stock price moved up, we sold these for a big gain and used the profits plus additional funds to buy the next month out.  Then, as the short squeeze developed, we bought leaps.   The compounded gain from the rollovers from the first calls we bought was about 30 times. The absolute profits were huge, but of course Ericopoly had much higher percentage gains in his portfolio because we only put a small percentage of our assets into the trade.

[nodnub]

We would buy some nearly every day and swap stories of what prices we got.  I remember getting an email from him one day stating that at closing he got 50 contracts of the $160 strike 2008 for 80 cents.  Just imagine... the stock broke $300 before that expired.

 

That was a great trade.  Now here is a question, even with hindsight.  What have been a reasonable amount of one's portfolio to put in the trade.  Given that the position could have gone to zero.

Personally, I would think it would be 0.5 to a 1% position, maybe 2%.  I just can't see putting more than that in options.

 

Thoughts?

 

Without knowing anything about the company... I would agree. 

 

however, there was lots of discussion about the hedge funds short manipulation of the company on the old MSN Board. A lot of the manipulation was confirmed when the lawsuit against the hedges was filed in late July 2006. I don't recall the option premiums immediately after that but the shares were still at a low point. For those that read the lawsuit and trusted Prem's version of events, it was a confirmation of a lot of what was suspected. A lot of the bad hedgie behaviour was finally laid out in black and white. Although, it had been widely discussed on here prior to the lawsuit (there was the short-lived website attacking Prem Watsa etc, etc).

 

 

[Uccmal]

From my records:  wfc jan 2011 - 22.50 calls on March 31st, 2009 - 3.50 -stock was $16.00.

I paid 4.11 some time in February 2009.

Sold these in on May 5th when the stock was at $23.00.

 

Sold some wfc jan 2011 - 20.00 calls on March 6th at 1.40.  bought at about 3.50 average - not your stellar trade but context is everything.  I bought SPY calls at the absolute bottom of the market on March 8th with the proceeds on the thinking that the S&P would outlast WFC if push cam to shove.

 

 

[Aberhound]

The FFH options seemed riskier at the time. I remember debating with myself over the $120 calls at $3.50 or so compared to the $140 calls at $1.60 or so and I bought the $120 calls. I thought the $160 calls were too risky to consider and that all the one year calls were too risky. The uncertainty wasn't whether FFH would rise back from $100 to $150 or so, but whether it would recover in time. It was the end of June and my fear was that another bad hurricane season like 2004 and 2005 meant another round of bad dilution. The rationale for the purchase was classic Munger analysis when I realized that the chance of another bad season for no more likely than usual and "recency bias" caused the fear of hurricane to be higher than was rational. Hurricane insurance prices were therefore too high for the same reason so the likely result was that 2006 would be a good year for Fairfax. It turned out to be a year of unusually low hurricane activity and Fairfax enjoyed excellent results. It could have been a bad year for investments as Prem had been warning of the crash since 2003. The amazing part was how few contracts were being traded. It was as if the only buyers were people from this board. Even so I was only willing to bet 5% of my portfolio. The 5% limit proved beneficial when I subsequently tried buying bank calls in late 2008 during the crash and unfortunately I chose Washington Mutual calls which became worthless.

[nodnub]

The FFH options seemed riskier at the time. I remember debating with myself over the $120 calls at $3.50 or so compared to the $140 calls at $1.60 or so and I bought the $120 calls. I thought the $160 calls were too risky to consider and that all the one year calls were too risky. The uncertainty wasn't whether FFH would rise back from $100 to $150 or so, but whether it would recover in time. It was the end of June and my fear was that another bad hurricane season like 2004 and 2005 meant another round of bad dilution. The rationale for the purchase was classic Munger analysis when I realized that the chance of another bad season for no more likely than usual and "recency bias" caused the fear of hurricane to be higher than was rational. Hurricane insurance prices were therefore too high for the same reason so the likely result was that 2006 would be a good year for Fairfax. It turned out to be a year of unusually low hurricane activity and Fairfax enjoyed excellent results. It could have been a bad year for investments as Prem had been warning of the crash since 2003. The amazing part was how few contracts were being traded. It was as if the only buyers were people from this board. Even so I was only willing to bet 5% of my portfolio. The 5% limit proved beneficial when I subsequently tried buying bank calls in late 2008 during the crash and unfortunately I chose Washington Mutual calls which became worthless.

 

Aberhound, your comments jogs my memory.  I recall that it seemed that way to me at the time too.  My recall of the details was clouded by nostalgia and hindsight.

[jb85]

thanks for all the great replies.  Definately sounds like an interesting situation. 

 

in response to net net's question of how much to allocate... i think that largely depends on your situation.  If i was running a portfolio of other peoples money, i would allocate much less, but for me... I'm in my 20's and if i had lets say 100K i would not have a problem allocating 30K to that one trade, if the payoff was 40:1 and the risk of loss was 50/50.  I know that sounds risky, but after reading up on ericopoly's logic as to why he bought, i have to agree with him.  If i lose 20-40K, it really only sets my retirement back a year or 2...If i win $1 million, i am ahead by atleast a decade...If you play enough bets with those odds, and don't risk your entire net worth on any one bet, you will be very rich.  trick is to find even 1 or 2 of these kinda bets in a lifetime.  i doubt they occur more often than that

[twacowfca]

thanks for all the great replies.  Definately sounds like an interesting situation.  

 

in response to net net's question of how much to allocate... i think that largely depends on your situation.  If i was running a portfolio of other peoples money, i would allocate much less, but for me... I'm in my 20's and if i had lets say 100K i would not have a problem allocating 30K to that one trade, if the payoff was 40:1 and the risk of loss was 50/50.  I know that sounds risky, but after reading up on ericopoly's logic as to why he bought, i have to agree with him.  If i lose 20-40K, it really only sets my retirement back a year or 2...If i win $1 million, i am ahead by atleast a decade...If you play enough bets with those odds, and don't risk your entire net worth on any one bet, you will be very rich.  trick is to find even 1 or 2 of these kinda bets in a lifetime.  i doubt they occur more often than that

 

That's a very good strategy, given your age and lifetime earning potential.  There was an academic study that was well received a few months ago.  It showed that taking more risk early in life pays off better than taking a steady amount of risk each year of investing in a retirement plan.

[twacowfca]

We would buy some nearly every day and swap stories of what prices we got.  I remember getting an email from him one day stating that at closing he got 50 contracts of the $160 strike 2008 for 80 cents.  Just imagine... the stock broke $300 before that expired.

 

That was a great trade.  Now here is a question, even with hindsight.  What have been a reasonable amount of one's portfolio to put in the trade.  Given that the position could have gone to zero.

 

Personally, I would think it would be 0.5 to a 1% position, maybe 2%.  I just can't see putting more than that in options.

 

 

Thoughts?

 

That's the rub.  You can be right with your thesis, but premature, and you're toast!  I would never buy short term options on speculation without the high probability of one or more short term catalysts influencing change during the option term. I also look for the possibility of experiencing a relatively big move that has the potential to be a grand slam home run for short term options.

 

I learned this lesson the hand way a few years ago.  Since then, the grand slams have greatly outweighed the strikeouts.

 

1% to 3% of portfolio value max for short term options seems about right for us, but if you're young with money to spare, and you had very high confidence in an idea, after adjustment for likely overconfidence bias, you could go higher.

[philassor]

Buffet would get 50% return because he has 70 years experience in the stock market. I  believe Ericopoly on this board had a 20 000% return over the last 10 years (about 70% annualized return). You can ask him how he did it.

 

BeerBaron

 

 

That's my RothIRA account with that return (according to Fidelity's calculations).  And to date (as of 8/31/2010) it's 99.19% annualized for a total of 18,465% cumulative since 2/1/2003.  The FFH options had a lot to do with it.  Earlier this year the cumulative return was something like 24,000% but since end of April it has pulled back.

 

Blended (including my taxable account) it's 61.64% annualized since 2/1/2003 for a total of 3,709% cumulative.  The reason the RothIRA outperformed is that I manage it with a different mentality, due to taxes.  It was also a smaller sum so taking a huge risk on it didn't matter to me.

 

Another board member who doesn't post anymore (dengyuthenugget) has done 170% annualized since 2005 or so (perhaps it was 2004) -- overall, all accounts combined.  Again, credit the FFH options for quite a bit of that. 

 

 

 

Eric, Thank you for sharing with us how you accomplished your extraordinary performance; there is no question that your personal life story is inspiring.  :)

 

There is also no question that your talent,intensity and guts met opportunity and you played big and won Buffett style (fat pitch).

However, we must put things in context; extreme fear was driving the Fairfax call options to a ridiculously low level, yet this board's confidence in Fairfax (and your own confidence) was rock solid  allowing your multiple leveraged bullish super bets.  Such situations  are rare in a lifetime and I don't believe your extraordinary performance of 60% annualized over 6 years is sustainable in the longer term (say 20 years).  I am in the uccmal camp here cautioning that the very best investors cannot return more than 20-30% annualized in a sustained manner over the long run.

Even though the collective knowledge of this board is very substantial and impressive,  there are probably a few greener investors out there who could be tempted into believing the impossible that is why I am posting this note of caution.

[ERICOPOLY]

Such situations  are rare in a lifetime and I don't believe your extraordinary performance of 60% annualized over 6 years is sustainable in the longer term (say 20 years).  I am in the uccmal camp here cautioning that the very best investors cannot return more than 20-30% annualized in a sustained manner over the long run.

 

There won't be a repeat, I'm not playing that game anymore.  It is fun to have that record, but I'm not ever going to run with that leverage again so it won't be repeated.  I will be extremely pleased if I get about 16.7%, then 14.5%, then 12.5%, then 11.1%, then 10%, etc... There's a number there that I want to clear every year and those numbers will get me there.  So my hurdle rate is getting much more attainable... I don't need big leverage to get there.  

 

Here is the thing.  Around mid-2006 when I bought the first batch of those calls the maximum I could put into investments of my own choosing (outside of my limited menu 401k plan) was a sum that amounted to about 2x my annual salary (that was the total combined size of my taxable account and RothIRA).  Given my age at the time, I didn't worry about losing the whole thing -- the other 1/3 of my liquid funds were in my 401k and for my age that was plenty of saving -- I would be ahead of most people my age even if I lose the 2 yrs income.  So it was a risk I could afford to take, even though it was 100% of those accounts.

 

I look at personal portfolio allocation in terms of what you can afford to lose, not what % you have allocated to any one thing.  Look, if you are 25 yrs old with no kids, have $30,000 in your trading account and can save $15k a year to put towards buying new investments, don't be afraid of putting the whole damn thing in FFH calls with 140 strike for $2 a pop for potential (and seemingly likely) 40x return.  You get a million if you are right..  You don't lose 100% if it goes wrong... you only lose 2 yrs of savings.  There's a really big difference between losing 2 yrs of savings and losing $5 million close to age 40 (the whole pot) when you can only replenish at a rate of $15k per year.  

 

At age 25 you can afford to lose 100% if it's 2 yrs of savings.  But you can't afford to lose $5m at age 40 if it's all you have and you save at the same rate as that 25 yr old.  That $25k was worth a million 8 or 9 months later!

 

So, I have always had this mentality towards my investments.  Percentage allocations only matter when your portfolio size is significant relative to your means of replenishment.

 

I blew it though with those options -- I should have just put it all in the higher strike calls instead of getting those 70 and 90 strike calls.  The reason being is that if it went wrong those calls didn't offer any safety much to speak of... so if you are going to risk it you might as well go for the big payout.  That was costly -- they made money of course, but not what it could have been.  Not that I'm unhappy, but I could have achieved the same results with less money on the table by just raising the strikes on those options.  I should have bought more of the $140s and $130s which is what I was buying too.

 

[Uccmal]

Eric, To be clear... When we were buying those calls FFH did not look anything like a sure thing.  I'd have to check but I am pretty sure the calls went into a loss position right away.  Mine were all Leaps.  To this day I have short term calls only once or twice and the result has been a wipeout. 

 

June 2006 was when I first bought - FFH started to look as though it would survive by this point.  Then came the lawsuit, and then the restatement.  It was exciting but not alot of fun. 

 

My observation is that most people would not invest in these at the time because FFH looked like too much of a wipeout.  Exact same thing happened in March of 2009.  And the exact same thing was happening on this board this summer when blue chips had reached generational lows. 

 

 

[calonego]

There are a ton of people on here that bought those LEAPS and calls.

I remember being 30 or 40 % of the open interest in the 120s and about half the interest in the 140s when they started printing those (back in early '06?).

I called a buddy of mine (he's on this board) and between him and his cousin, they were almost the rest of the interest! There may have been 10 or 20% that I couldn't account for, but it was likely people from this board.

 

We had a higher base so the % returns aren't as crazy, but dollars are dollars.

Buying was easy, holding it was so difficult (I kept rolling it to deal with my fear of an implosion).

That was one of the most exciting times of my life.

I remember being in Florida that winter or fall and seeing a "Sanjeev's out for lunch" squeeze on my blackberry... That one squeeze was a small house!

[Guest dealraker]

There is something interesting-but not surprising- about the posts here regarding investment returns.  I'd guess that many here reading these are thinking the same thing but writing those thoughts may instigate something called the Karpman Drama Triangle.

 

Enough from me.

[Myth465]

Damn where the hell was I. Someone should have sent me an email or something.

[Uccmal]

I still owe Sanj  alot of lunches for going out that day.....