Buffett Bulls Drive Berkshire Calls to Two-Year High: Options

Warren Buffett’s signals that shares of his Berkshire Hathaway Inc. (BRK/A) are undervalued have sent bullish options to the highest levels in two years.

The number of outstanding call options to buy Berkshire’s Class B shares versus puts to sell rose to 1.26-to-1 on March 5 after reaching 1.31 on Feb. 10, the highest level since February 2010, according to data compiled by Bloomberg. The cost of puts protecting against a 10 percent drop fell to the lowest level since May relative to calls betting on a 10 percent gain, data on 30-day contracts show.

Buffett, 81, the world’s most-successful investor and third-richest person in the Bloomberg Billionaires Index, said he plans to repurchase stock “aggressively” when Omaha, Nebraska-based Berkshire trades at less than 1.1 times net assets. The company has lagged behind the Standard & Poor’s 500 Index since last year’s low in October.

“It’s a bona fide bargain,” Todd Lowenstein, who helps oversee about $17 billion for Highmark Capital Management Inc. in Los Angeles, said in a telephone interview yesterday. Buffett wants “to let investors know that he’s got a bazooka out there and can go out and buy the stock,” he said.

Buffett, who transformed Berkshire from a failing textile manufacturer in 1965 into an insurance-and-investment firm valued at $194.5 billion, didn’t return a message seeking comment on the options trading.

First Buyback

Berkshire’s chairman and chief executive officer announced the repurchase program, the company’s first, in September. The stock, which has traded at an average multiple to book value of 1.5 over the last decade, surged after the Sept. 26 repurchase announcement, curbing the company’s opportunity to buy. As of Dec. 31, Berkshire had spent $67 million.

While the Standard & Poor’s 500 Index has added 22 percent since its one-year low on Oct. 3, Berkshire’s Class B stock has gained 12 percent. Insurance companies in the gauge advanced 23 percent, and S&P 500 financial shares jumped 28 percent.

Buffett said on Feb. 25 in his annual letter to shareholders he intends to “repurchase stock aggressively” at or below 1.1 times book, while refraining from buybacks if Berkshire’s cash slips below $20 billion. Berkshire’s Class A shares trade for 1.18 times the company’s per-share book value of $99,860. Those shares have risen 2.7 percent to $117,855 this year. The Class B shares closed at $78.47 yesterday.

The company, which had $37.3 billion of cash on Dec. 31, can “clearly increase” its value by repurchasing shares at the right price, Buffett said in his letter to shareholders. Still, Buffett told investors not to rely on repurchases to provide a floor for the shares.

‘Bids Will Fade’

“You should know, however, that we have no interest in supporting the stock and that our bids will fade in particularly weak markets,” Buffett wrote.

The company’s Class A stock is probably worth $178,366, hedge-fund manager Whitney Tilson said in a Feb. 26 presentation. That was 49 percent more than the last closing price for the shares.

Buffett “would love to be able to buy back 10 to 20 percent of total shares,” Tilson, who has owned Berkshire stock for 14 years and oversees $150 million as managing director at New York-based T2 Partners LLC, said yesterday in a phone interview. “He has the balance sheet and the cash flow.”

Ownership of bullish Berkshire contracts increased 23 percent to 202,502 on March 5 from the last monthly options expiration on Feb. 17, while put open interest gained 20 percent to 160,942, according to data compiled by Bloomberg.

Implied Volatility

Implied volatility, the key gauge of options prices, for 30-day contracts closest to Berkshire’s stock price dropped 64 percent since its Aug. 8 high to 16.5 yesterday. Implied volatility for contracts 10 percent below the stock price was 22.25, while the measure for options 10 percent above was 15.99, driving the price relationship known as skew to a nine-month low of 6.26 points.

“In the past month, option traders are increasingly expressing bullish views in Berkshire’s B shares,” Terry Wilson, an equity derivatives strategist at Credit Suisse Group AG in New York, said in an e-mail yesterday.

Buffett said last month the board has picked his eventual replacement without identifying the choice, saying that directors were “enthusiastic” and have had “a great deal of exposure” to the person designated to take over as CEO. Berkshire, which relies on Buffett to oversee a $77 billion stock portfolio and operating units with more than 270,000 workers, didn’t specify a timeline for the switch.

‘There’s Risk’

“There is risk to the stock price when a succession takes place,” said Tim Ghriskey, who oversees $2 billion as chief investment officer of Solaris Group in Bedford Hills, New York. “At some point that could be an opportunity, but right now there’s risk.”

The Chicago Board Options Exchange Volatility Index, known as the VIX (VIX), rose 16 percent, the most since Nov. 9, to 20.87 yesterday. Since reaching a two-year high on Aug. 8, it lost 57 percent through yesterday. It fell 8.6 percent to 19.07 today.

Since the last options expiration on Feb. 17, four of the five contracts with the biggest increases in ownership were calls, data compiled by Bloomberg show. March $82.50 calls, priced 5.1 percent above yesterday’s close for the Class B stock, gained the most, adding 10,910 options to 21,386. Those also had the biggest open interest among Berkshire contracts.

Berkshire’s holdings range from shares of Coca-Cola Co. (KO) and International Business Machines Corp. to units in the railroad, electric utility, homebuilding and candymaking industries.

“Cheapness is a catalyst” for the stock to rise, Tilson said. Berkshire is “a collection of fabulous operating businesses.”

To contact the reporters on this story: Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net; Joseph Ciolli in New York at jciolli@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net

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