cellardoor1

Berkshire Hathaway Credit Risk, Index Puts Are Overblown Worries

Um, no...that might be why the innumerate investors are running away. Seriously, chill w/the voodoo math.

Here's a simpler proposition for you -- the value of a European put option cannot be greater than the strike. Why? Well, at worst, the underlying security goes to 0, which results in a payout of (Strike - 0) when the option holder gets to sell something worthless for Strike dollars.

In fact, by applying basic logic, one can lower this ceiling to (strike - 0) x (discounting effect of receiving cash flows in the future), since one cannot receive the maximum cash flows until expiry, even if the index goes to 0 and stays at 0 today.

One corner case re: the above is that in an environment with negative nominal interest rates, the maximum payout might be (strike-0) x (inverse of the deflationary effect until option expires).

In short -- his notional exposure is the maximum exposure

On Nov 22 05:43 AM djw wrote:

> > Berkshire’s maximum exposure is $37.0 billion,
> What makes you think the max loss is 37 bn, the 10Q says this is
> the notional portfolio value. I ran some numbers and my quick and
> dirty estimate is a loss of 86bn if S&P was 0 at expiry. The
> puts were written close to market, lets say the strike was 1500 and
> market was 1500, the vol was 18%, with risk free rate of 3.75% and
> 15 yr term the fair val is about 81 pts (delta 0.1281) and if we
> have a premium of 4.66 bn and that is equivalent to 230,000 exchange
> contacts at $250 a point. So if S&P is zero the loss is 86 bn.
> I believe the notional portfolio value is the delta, divided into
> the premium (4.66/0.12181 = 36.4 bn)
> Now at S&P = 800 risk free rate 3% long term vol 35% the time
> to run 13.5 yrs the put fair val is 538 pts (delta .33) and fair
> val 30 bn. Lets say there has been a 20% gain due to currency so
> net is 24bn the loss to be recorded for 2008 is 19 bn the notional
> portfolio (currency adjusted) is now (24/.33) = 73 billion.
> This is why investors are running away.