Berkshire Profit on Goldman Sachs Passes $2 Billion

[Trader666]

Agree and will take your suggestion.

Quick point first... does he really know options or is he just good at spewing jargon? I'm not an options expert but one of the things he wrote struck me as absurd on sight. Namely, that Buffett is "carrying a $delta of approx. 1.6MM per tick on SPX"

Here's why that just looks wrong to me... on what planet does put delta EVAPORATE as the put moves deeper in the money over time? On the contrary with every option I've ever traded but it would have to move to 0 instead of -1 for his numbers to hold up. For simplicity let's freeze the delta at "1.6MM per tick on SPX." The cash index moves in .01 increments so that's $160 million per point. Now let's say the index falls to zero. 980 * $160 million = $156.8 billion, which is more than 4X Berkshire's maximum liability of $37.1 billion on all its index put contracts... not to mention that the S&P 500 is just one of the four.

Quote from asiaprop:

Atticus still does not get that the 9b or 10b he is talking about is gross and not including premium.

Nor does he understand the trade within the proper context, in fact he behaves as if WB's life depended on this single trade. I stopped engaging with this guy directly as he put forth lies and could not sustantiate any of his earlier claims. I recommend to stop feeding this guy. He knows options, fair enough, but when he gets agitated and especially when he gets something wrong he simply cant get beyond his arrogance and starts calling people names and starts lying. He is absolutely not in control of his temper. He even sent me PMs thats how much he was on fire, lol. But above all he fucked up on several issues and simply cannot admit....go figure...

 

[atticus]

Quote from atticus:

Buffet states a 9 billion dollar liability if indices lose 25% from inception. The contracts were atm, so 1135.50 on SPX would result in a 4.1 billion net-loss at expiration.

Buffett's talk of a $10B liability in the annual letter infers an SPX valuation <1135 and we're currently trading at 980.

Anyone can solve for convexity at locale, and he's carrying a $delta of approx. 1.6MM per tick on SPX. He's still short a lot of convexity to arrive at a loss of 37B at 0.00 on SPX. At 970 he's carrying a liability [including the prem] of ~$11.5B if the contracts were to expire on 7/24/09.

No mention of an attenuation of the liability is mentioned anywhere in the letter. No hedge.

Absolutely my mistake. 0.16MM per tick, not 1.6MM; 16MM per point in SPX at 970 to arrive at $15.5B at zero, assuming no convexity, using current pricing. There is a lot of convexity remaining in the trade. The delta at 900 is approx 0.185MM per tick. Thanks Optioncoach.

 

[Trader666]

ROTFLMAO!!!! I first pointed this out to you last night here:

I'm not an expert in options like you pretend to be but I can tell this is wrong just by looking at it.
http://www.elitetrader.com/vb/showthread.php?s=&postid=2516638#post2516638

But you stubbornly insisted you were right:

The 1.6MM figure is accurate
http://www.elitetrader.com/vb/showthread.php?s=&postid=2516712#post2516712

Then, 12 minutes after I EXPLAINED why it looked wrong to me here, you magically admit you were wrong.
http://www.elitetrader.com/vb/showthread.php?s=&postid=2517396#post2517396

But here's the hilarious part... I'm not an expert on options, you pretend you are yet I could tell just by looking at your number that it was wrong. You couldn't, even after I told you it was. You needed it explained to you. Some expert. You're a pathetic joke

Quote from atticus:

Absolutely my mistake. 0.16MM per tick, not 1.6MM; 16MM per point in SPX at 970 to arrive at $15.5B at zero, assuming no convexity, using current pricing. There is a lot of convexity remaining in the trade. The delta at 900 is approx 0.185MM per tick. Thanks Optioncoach.

 

[asiaprop]

the figure I agreed with you on was the gross p&l until you came out of the woods claiming this 9billion was net of premium received which is STILL WRONG. But, hey, you admitted you got it wrong on your delta, great start. We can work from here...

Quote from atticus:

Quote from asiaprop:

while you seem to be pretty accurate with your unrealized p&l evaluation you still stubbornly ignore the trade in its larger context.

I sent one PM thanking your for your contribution to this thread. You sent me an unsolicited PM two months ago, while my first PM to you was last night... so more BS from asiaprop.

 

[atticus]

Quote from asiaprop:

while you seem to be pretty accurate with your unrealized p&l evaluation

I missed the decimal and you didn't question it. I admit I missed the decimal when I reduced it from point to tick-value, but you're backpeddling after admitting the number was good. You're an oxygen thief.

 

[asiaprop]

Do you see I used the term p&l evaluation ? I never even commented on your delta figure, ;-) You are digging a deeper and deeper hole for yourself, lol.

Just one last question: Do you still believe your 9billion p&l mtm loss is after factoring in the premium he received on the puts or before? Dodging this question clearly shows you know precisely what is going on but cannot admit another mistake of yours.

Quote from atticus:

I missed the decimal and you didn't question it. I admit I missed the decimal when I reduced it from point to tick-value, but you're backpeddling after admitting the number was good. You're an oxygen thief.

 

[atticus]

Quote from asiaprop:

Do you see I used the term p&l evaluation ? I never even commented on your delta figure, ;-) You are digging a deeper and deeper hole for yourself, lol.

Just one last question: Do you still believe your 9billion p&l mtm loss is after factoring in the premium he received on the puts or before? Dodging this question clearly shows you know precisely what is going on but cannot admit another mistake of yours.

I'll get back to you later today. The answer is obvious, but with a qualifier. 37.1B * .25 = 9.275B at expiration. I am not attempting to avoid it, there is a issue with the letter.

 

[atticus]

An issue with a marked-loss vs an expiration payoff on Buffett's standard 1514 short European put. First with respect to Buffett's comments at the bottom of page 18:

The SPX EOY value was 903. 903/1514 -1 results in a 40% loss on the index value taken from the put-strike. Short the 10y 15% vol 1514-strike European put at 2% LIBOR and SPX=1514 is valued at $4,900,000,000. The 1514-strike put at SPX 903, 6-months later, 30% vol and 2% LIBOR is valued at 19,874,125,720. The LIBOR at 2% at EOY 2008 is grossly overstated and would result in an additional $3.4B ($23,300,699,120 value) loss on the option, due to a reduction on the implied forward (synthetic strike increase), if had I used 1% LIBOR which was indicative at the end of 2008. IOW, the risk-free rate drop hurts the position as it's massively-sensitive to rho.

The BS-model loss on the 10-year 1514 European put at 2.00 LIBOR is $14,974,125.720. The BS-model shows a 4-fold increase on the option under those constraints, yet Buffett is modeling a double. The loss declines as you add duration; roughly $300MM per year. A 15-year model would produce a loss of roughly $13.5B. We can't mark a duration, but simply taking the average of the dates listed puts it in the 15-year range.

An aggressive valuation, favorable to the seller (LIBOR at 2%, vol under market), results in a marked-loss of $13,500,000,000 at a blended 15Y expiration. A vol at inception of 15%, and a vol at MTM of 30%. Buffett's MTM loss of $5.1B ($10B liability less $4.9 premium) assumes that his European puts are averaging a 10% vol with the SPX at 903.

If Buffett can keep the premium and loss-reserves then more power to him, but his calculation on MTM loss under GAAP is not remotely realistic. Of the other three indices, only the FTSE outperformed in 2008, so using the foreign-indices adjusted for vol (incept to MTM) would result in a larger loss. The true impact is the risk-free rate. An indicative LIBOR increases the loss tremendously.

Feel free to run the numbers yourselves:

BS for European options
10-year term
1514 strike on standard European put
Vol at inception: 15% at SPX 1514
Vol at MTM: 30% at SPX 903
LIBOR at inception: 2%
LIBOR at MTM: 2%

I am in agreement that it's not much of a concern if the GAAP reserve-pool is not netted like a swap at some fixed-interval. It's amazing to me that no money is changing hands on the variance on haircut. Buffet is marking vol to 10% under GAAP on the MTM, but 15% on the inception of the contracts. The only advantage to Buffett's position was the up&out -skew, but the more than doubling of vol in the interim is an order of mag more important.

Even at a MTM vol of 20%, the loss, net of premium, would be >$10B.

So, either Buffett is playing fast and loose with the marks, or this thing is a non-standard put; handicap, floating-strike, or something with another embedded feature. Another solution is that the options were considerably otm; an increase in synthetic vol through a reduction in initial delta. Obviously that is unlikely as the SPX never traded above 1573.

The only other alternative is that there is a massive hedge that is somehow been neglected in the annual letter.

 

[asiaprop]

with all due respect, this is what I have said the whole time: You do not have the information needed to fully evaluate this trade. You make assumptions and read something into the letter to investors that Buffett never said.

I am not sure (nor do I really care) whether you are being sarcastic by suddenly turning 180 degress...and you still have not answered my last question.

Quote from atticus:

An issue with a marked-loss vs an expiration payoff on Buffett's standard 1514 short European put. First with respect to Buffett's comments at the bottom of page 18:

The SPX EOY value was 903. 903/1514 -1 results in a 40% loss on the index value taken from the put-strike. Short the 10y 15% vol 1514-strike European put at 2% LIBOR and SPX=1514 is valued at $4,900,000,000. The 1514-strike put at SPX 903, 6-months later, 30% vol and 2% LIBOR is valued at 19,874,125,720. The LIBOR at 2% at EOY 2008 is grossly overstated and would result in an additional $3.4B ($23,300,699,120 value) loss on the option, due to a reduction on the implied forward (synthetic strike increase), if had I used 1% LIBOR which was indicative at the end of 2008. IOW, the risk-free rate drop hurts the position as it's massively-sensitive to rho.

The BS-model loss on the 10-year 1514 European put at 2.00 LIBOR is $14,974,125.720. The BS-model shows a 4-fold increase on the option under those constraints, yet Buffett is modeling a double. The loss declines as you add duration; roughly $300MM per year. A 15-year model would produce a loss of roughly $13.5B. We can't mark a duration, but simply taking the average of the dates listed puts it in the 15-year range.

An aggressive valuation, favorable to the seller (LIBOR at 2%, vol under market), results in a marked-loss of $13,500,000,000 at a blended 15Y expiration. A vol at inception of 15%, and a vol at MTM of 30%. Buffett's MTM loss of $5.1B ($10B liability less $4.9 premium) assumes that his European puts are averaging a 10% vol with the SPX at 903.

If Buffett can keep the premium and loss-reserves then more power to him, but his calculation on MTM loss under GAAP is not remotely realistic. Of the other three indices, only the FTSE outperformed in 2008, so using the foreign-indices adjusted for vol (incept to MTM) would result in a larger loss. The true impact is the risk-free rate. An indicative LIBOR increases the loss tremendously.

Feel free to run the numbers yourselves:

BS for European options
10-year term
1514 strike on standard European put
Vol at inception: 15% at SPX 1514
Vol at MTM: 30% at SPX 903
LIBOR at inception: 2%
LIBOR at MTM: 2%

I am in agreement that it's not much of a concern if the GAAP reserve-pool is not netted like a swap at some fixed-interval. It's amazing to me that no money is changing hands on the variance on haircut. Buffet is marking vol to 10% under GAAP on the MTM, but 15% on the inception of the contracts. The only advantage to Buffett's position was the up&out -skew, but the more than doubling of vol in the interim is an order of mag more important.

Even at a MTM vol of 20%, the loss, net of premium, would be >$10B.

So, either Buffett is playing fast and loose with the marks, or this thing is a non-standard put; handicap, floating-strike, or something with another embedded feature. Another solution is that the options were considerably otm; an increase in synthetic vol through a reduction in initial delta. Obviously that is unlikely as the SPX never traded above 1573.

The only other alternative is that there is a massive hedge that is somehow been neglected in the annual letter.

 

[atticus]

Quote from asiaprop:

with all due respect, this is what I have said the whole time: You do not have the information needed to fully evaluate this trade. You make assumptions and read something into the letter to investors that Buffett never said.

I am not sure (nor do I really care) whether you are being sarcastic by suddenly turning 180 degress...and you still have not answered my last question.

Of course the last-line is sarcasm, aimed at Buffett's marks/reserve accounting. He quotes his style here:

It doesn't leave out the potential for a long gamma hedge, but why the billions in GAAP reserves? Coincidentally equal to his dubious mark to market loss on the 1514 put?

He sold the bottom in volatility and bought the top in the SPX; he can't add edge to the position in gamma at those levels. Any adequate hedge would render moot the $4.9B in credit. If so, then offer any position at vol+time that could adequately add convexity-protection; on vega or gamma.