Buffett-Style Options: Why ‘Dry Powder’ Might Be the Wrong Strategy

During their recent episode of the Value Options Letter and Acquirers Podcast, Travis and Carlisle discussed:

• Why Warren Buffett Keeps Billions in Cash—And What Individual Investors Can Learn
• Cash-Secured Puts vs Holding Cash: Which Strategy Generates Better Returns?
• How Cash-Secured Puts Can Lower Your Stock Purchase Price
• How the Wheel Strategy Generates Passive Income From Stocks
• How Market Volatility Creates Better Options Selling Opportunities

TRANSCRIPT

[Tobias] This is the Value Options Podcast. I’m Tobias Carlisle, joined as always by my co-host, Tim Travis. Tim, how are you?

[Tim] I’m doing well. Great to see you. It’s been too long.

[Tobias] Yes, it has. Let’s do a quick reminder for everybody. What are value options?

[Tim] So value options are utilising cash secured puts and covered calls on already undervalued stocks. So we’re only dealing with businesses that we want to own at prices that we want to own them at. And then these are conservative income generating tools to generate income and reduce risk and to manufacture cheaper entry prices into the stocks.

[Tobias] So perhaps two of the most conservative investors out there, Buffett and Seth Klarman at the Bopost Group, have been known to carry large amounts of cash on their balance sheets. And Klarman’s been criticised for that in the past. Buffett is often criticised about that right at the top of the market too, but it’s no secret.

Lots of folks know that Buffett’s got record amounts of cash on his balance sheet. What do you think about that? Good idea, bad idea?

Why Warren Buffett Keeps Billions in Cash—And What Individual Investors Can Learn

[Tim] Well, I think they do it to have that optionality because when markets are expensive, you want to be able to have dry powder so that you can buy on the dips. So that’s very rational behaviour, but it’s a huge drag on a portfolio, especially when you’re talking several hundred billion dollars like it is in the case of Berkshire Hathaway. Now, naturally that’s invested in treasury bills.

So with rates where they are, they’re doing okay on it. But that’s one of the real benefits of value options, Toby, is that by default, our strategy is buying stocks after they’ve dropped even further. They’re already undervalued, but if you see a Berkshire Hathaway or a Pepsi drop 20, 25%, we might have a sold put down there and now we’re getting exercised and we’re buying it at truly bargain prices and we can ride the stock higher.

Once we’re exercised on a put, we can do the wheel strategy where we start selling covered calls on that. And what I think is more optimal than treasury bills and just holding cash kind of like the big boys do is that we’re targeting double digit returns on the vast majority of these positions, often in the 20% range. So you get paid to wait and your worst case scenario is being the one that’s buying when stocks are really becoming undervalued.

[Tobias] That’s the key to the value options. On one hand, there’s always two outcomes. When you hold an option, it expires worthless and because they’re cash secured, you have to put cash up and you want to make sure that you’re getting sufficient premium on the cash that secures the put.

And the other outcome is that the stock actually gets put to you. And so in that instance, you want to be in a stock that you want to own. And so that’s what Buffett and Bopost have been very good about identifying very high quality stocks, being extremely patient.

Cash-Secured Puts vs Holding Cash: Which Strategy Generates Better Returns?

And this is really a third way of doing that. You identify the stock that you really want to own, and then you find an option that gives you sufficient premium where if you don’t get put the stock, you’re very happy with the internal rate of return on the premium.

[Tim] Correct. Exactly, Toby. And we actually have some statistics that we can say.

And so folks listening to this, this is an investment publication. It’s not an investment advisory and past performance is not indicative of future results, of course. But so far we’ve had 12 closed trades on the site and 12 of 12 have been successful.

There’s two trades that are open wheels. So one, for instance, we sold a put on Amazon at $250. We got exercised in June at $250.

We collected $308 of premium. And now Amazon’s at like $256 and we sold calls on that Amazon stock as well. So that’s a great point where just because you get exercised on a put does not make it a losing trade.

It’s actually just you’re manufacturing your cheaper entry price into the stock and now we’re selling calls, kind of manufacturing a dividend on that stock. So very pleased with that so far. As far as open positions, we promised three to five trades a week was our promise.

But out of respect for our subscribers, we’ve done a lot more than that, Toby. So we’ve been busy on the recommendation side on the website. So there’s 114 positions.

Currently, as of the end of the day today on July 15th, 90 of 114 are in the green. So that’s really encouraging. And the ones that are in the red are pretty mild.

How Cash-Secured Puts Can Lower Your Stock Purchase Price

So far, I mean, look, the market’s been up. There will be much tougher times as well. We’re long term orientated investors.

But of course, the options provide that element of timing to generate income and reduce risk and to manufacture those cheaper entry prices. So we appreciate the subscribers that we have. And while I’m on the subject, Toby, we’ve got two more weeks.

The price doubles in two weeks. So those that become subscribers before July 31st, they’re grandfathered in at $99 a month or $999 a year. That price doubles at the end of July.

[Tobias] So just to recap, the value option strategy is to identify high quality, undervalued stocks that you would want to own and then to find an option trade around that that generates a high enough internal rate of return to justify the cash secured money that you have to put up into the account. You receive a premium. And then that has an expiry date.

So we can calculate an internal rate of return, assuming that the put expires worthless or the option expires worthless. On the other hand, if you have the stock put to you, you want to be very happy that you have invested in that stock long. And the service is to post three to five ideas every week that meet these criteria.

And then we publish all the results and tell you how to trade the position after we’ve established the position. And if the stock is put to you, then we initiate what Tim calls the wheel.

How the Wheel Strategy Generates Passive Income From Stocks

[Tim] Do you sell a put and you collect a premium upfront like Amazon? Okay. So we sold a $250 put.

We collected, I think, $308. It was a short-term option. I don’t even remember how many days, I won’t guess, but probably less than 30 or somewhere around there.

So I guess I will guess. But we got exercised. And then, so we owned it at a break-even of around 247-ish.

And then we sold calls. I believe we sold at 260, 265, something like that. Once again, relatively short-term.

So you’re basically manufacturing a dividend into the stock. You have decent upside potential. If you think Amazon’s going to double, you don’t want to sell the call there.

I like Amazon a lot. We actually have multiple Amazon positions on the website. So that’s not the only one, but that’s a way that you can kind of turn over that money and manufacture returns with that.

So that’s the wheel though. It’s just a multi-pronged process. And you can also do it with covered calls.

So we also had a Blue Owl Capital. We bought the stock and sold a call. The call expired worthless.

And so now we’re just selling another call on it. And that stock also pays like a 9% dividend. So yeah, so it’s an active process.

How Market Volatility Creates Better Options Selling Opportunities

And one of the things, Toby, that I think is dynamic about the value options letter is because it’s an active process, there’s days when it looks like the Iran war is over and oil prices drop. And so that creates volatility in oil stocks. So there’s several oil names that we’ve sold puts on at really attractive rates of return.

And we’re doing it when the volatility peaks on that. Other days you’ll get software’s dead headlines and you’ll get a golden opportunity to sell puts on some of these real high quality software stocks. And you could even lump Microsoft in there, that’s on the site.

So being able to take advantage of volatility, but not necessarily have to buy the stock at the current price, but you might be 15, 20% below the actual market price.

[Tobias] Fantastic. So folks, the current offer is half the full price that expires July 31. If you go to valueoptionsletter.com slash subscribe, then you can see for a free seven day trial, you can see the options trades in real time. And then if you elect to go ahead, you can do that and your price will be grandfathered and you’ll keep that price forever. So check it out.

[Tim] Thank you very much.

[Tobias] Thanks, Tim.

[Tim] Thanks, Toby.