When to Sell BRK.B Puts for Options Premiums, Potential Discount on Overpriced Stock
Berkshire Hathaway's 8% drop in 2023 earnings and its high price to free cash flow ratio suggest the stock will weaken and offer options premium sellers a discount on the stock.
By Donald E. L. Johnson
Cautious Speculator
Warren Buffett tells an optimistic story in his annual letter to shareholders.
Berkshire Hathaway’s 2022 annual report tells a sadder story.
BRK.B’s charts looked bearish before the annual report and letter were published. But it’s also looking over sold and my snap back at any time.
This may be a good time to put BRK.B on a watch list for selling cash secured puts.
Warren Buffett’s Berkshire Hathaway (BRK.A, BRK.B) weak 2022 earnings report and negative cash flows on investments, financings and operations may encourage some long-time BRK.B owners to sell the stock.
At the same time, investors who have had Berkshire on their buy watch list may be able to buy BRK.B at a discount by selling BRK.B expiration $290 strike cash secured puts for about $1.85 a share on a 100-share put options contract. There are no options on BRK.A shares.
The stock closed Friday at $304.02. If the stock closes on March 17 below the $290 strike and stock is assigned to the puts seller at $290, or a net debit of $288.15, the discount on the stock will be about 4.6% from Friday’s close or about 20% from the stock’s 52-week high of $362.10. The net debit is the stock price minus the options price ($304.02-1.85). The probability that the stock would close out of the money (OTM) on this trade is about 80%.
If the stock stays above the strike price, the puts seller would pocket the $1.85 puts premium for an annualized return on risk of about 10% if the trade or another one like it was repeated every 18 days for 12 months.
Some options traders may want to buy BRK.B for an even lower price and give the trade more time to work.
With support between $290 and $300 at Friday’s close, a cautious speculator might sell BRK.B April 21 $270 puts for about $1.50, give or take depending on the stock’s price when the trade was done. That would provide about a 11% discount on the stock from Friday’s close and about 25% from the 52-week high if it was assigned at $270 in 53 days. If the stock wasn’t assigned, the ARoR would be about 3%. The probability that the stock would OTM on this trade is about 89%. The lower the risk of assignment, the lower the ARoR.
Even if an investor is bullish on Berkshire, we’re in a bear market that is dragging a lot of good stocks with it as the above chart shows. This is making a lot of traders wary of buying stocks, but some may want to do moderately bullish trades like selling cash secured puts because the stock is close to being over sold.
If the stock drops quickly, a trader could quickly buy the puts back at a small profit or loss. Or she could wait to see what happens to the stock. Then, if the trade looks like a loser, she could buy back the puts before the options expire or take assignment and hope that she could make a profit on a quick snap back rally or when the stock and markets bottom and rally.
Sometimes, a stock will stage a nice rally right after a trader sells puts. In that case, the trader could quickly buy the puts back at a quick profit and move on to another trade.
Nobody can predict stock prices or markets. That is one reason traders need to plan what they will do under various scenarios.
In his annual report letter, which was released Saturday, Buffett expressed optimism about America. He expects the American “tail wind” to be good for Berkshire.
But Berkshire’s annual report shows:
Net cash flows from operating activities were $37.2 billion, down from $39.4 billion in 2021 and $39.8 billion in 2020.
Net cash flows from investing activities were a negative $87.6 billion in 2022 vs $29.4 billion in 2021 and a negative $37.8 billion in 2020..
Net cash flows from financing activities were a negative $1.7 billion in 2022 vs ma negative $28.5 billion in 2021 and a negative $18.3 billion in 2020.
Buffett is a great financial publicity man and salesman. He tries to minimize these results, but they are what they are and they suggest Berkshire's stock still is over valued.
In 2021, BRK.A’s P/FCF was a high 34.2 and BRK.B showed a 33.8 P/FCF ratio.
Compare that with some stocks owned by Berkshire and some that are in some of its businesses: AAPL's P/FCF is 24.4; ALL 7.6. AXP 6.8; CVX 8.4; HPQ 8.3; JNJ 24.2; KHC 31.2; KO 27.3; MCO 44.8; OXY 4.9; TRV 6.9; UNP 21.1.
LINKs:
Home Page. See my more than 90 articles on options trading, stocks and watch lists. If you read several of these articles, you’ll learn how my strategies are meant to work. No guarantees. Links to useful web sites are on the lower right corner of the home page. Scroll down.
Follow @realDonJohnson on twitter.com and FaceBook.com.
Selling in The Money Covered Calls Can Yield Big Annual Returns on Risk. By Donald E. L. Johnson
20 Ideas for Adjusting Your Stock and Bond Portfolio, by Christina Lourosa-Ricardo.
How to Beat Inflation Tax, Bear Market Tax With Dividend Stocks, Covered Calls, Cash Secured Puts, by Donald E. L. Johnson.
Wars Breed Inflation, Rising Interest Rates, Market Turmoil, By Donald E. L. Johnson.
Ways to use StockRover.com to analyze stocks
Calls vs Puts Options: What’s the Difference?
A video on how to place options trades on Think or Swim.