No. of Recommendations: 13
Here's a possible strategy, just made it up.
Observation: Berkshire Hathaway stock stays fairly close to fairly valued (the range is smaller for most other things), which is relatively easy to estimate and trends pretty well. This is a graph of a smoothed valuation metric. (basically a 16 quarter WMA of inflation adjusted book per share, scaled to match the average valuation multiple in the last 20 years. (smoothed line moved up to minimize RMS errors versus price line)
http://stonewellfunds.com/SmoothedRealValuePerShar...The ratio of current market price to that trend line has a standard deviation of 11.8% in the last 20 years.
The strategy:
Put 50% of your portfolio into Berkshire stock, hold the other half in cash.
Each month or quarter,
* Write a call option (covered call) backed by your stock, at the net exit price (strike + premium) that is one standard deviation above the current value of the trend line.
* Write a put option backed by your cash, at the net entry price (strike minus premium) that is one standard deviation below the current value of the trend line.
Every time the call you've written is exercised and your stock is called away, simply use the cash to buy back stock equal to half your portfolio value.
Every time the put you've written is exercised and you're "forced" to buy the stock cheaply, simply sell the stock (whatever brings you back to half stock) and write a new put.
So, your portfolio will be quite close to 50/50 stock and cash most of the time, with the occasional brief blip to 0% stock or 100% stock.
That's it.
Note that often the put or call that you are writing will be in the money. (big premium, almost certain to be exercised). That's normal for this strategy.
Over time you should get a return equal to the sum of:
* Half the average return from BRK, since you're averaging half long, around inflation + 3.5%. That's half of Berkshire's expected return of about inflation + 7%. That estimate is about 1% lower than history, but hardly a big stretch.
* The return of short term interest rates on half your portfolio. If you want maximum return, you'd back your options with an ever-renewed ladder of actual 3-month T-bills, which good brokers are fine with.
* A few percent from the average time value erosion of the short calls you're forever writing, on half your portfolio.
* A few percent from the average time value erosion of the short calls you're forever writing, on half your portfolio.
In a typical month, one of those two will raise a fair bit of cash.
I don't have the data to test this strategy. But I've essentially done it off and on by the seat of my pants, so I have a strong feel for what it does.
Jim
