Warren Buffett is beginning to say farewell to his equity derivatives.
Equity-index put options written by Berkshire Hathaway Inc. started expiring in June, and the last of them will be gone by January 2026. Buffett, Berkshire’s chairman and chief executive officer, initiated the deals between 2004 and 2008 to bet that stock prices would rise in the long run. The options, tied to four major equity indexes, added a total of US$2.4 billion to earnings from 2008 to 2017.
“This is a really unique piece of business,” Jim Shanahan, an analyst at Edward Jones, said in a phone interview. “Not a lot of companies besides Berkshire could have written this business. It demonstrates the unique power of this franchise and their size.”
Buffett, 87, already ended some other derivative bets, exiting his last credit-default agreement in 2016. His use of derivatives was sometimes controversial because he’d once lambasted them as “financial weapons of mass destruction,” later arguing that his bets were different and had no counterparty risk.
Berkshire’s contracts are European style, meaning that they can be exercised only at the expiration date. Since year-end 2008, the S&P 500 has nearly tripled and the FTSE 100 has surged more than 70 per cent.
“Things were a little haywire where banks were going belly-up and there was a lack of confidence in the financial markets and Buffett was betting on some degree of rationality coming into things,” said David Sims, president of Sims Capital Management, which oversees US$50 million including Berkshire Class B shares.
Buffett has likened the benefits of derivative wagers to the perks of his insurance operations. Berkshire received a total of US$4.2 billion in premiums upfront on the options that it has put to work for more than 10 years, just as the “float” generated by insurance premiums can be invested before any claims must be paid.
The derivative bets have created volatility in quarterly earnings, swings that Buffett said “neither cheer nor bother” him and his business partner, Charles Munger. Berkshire’s vice chairman, Munger defended the derivatives after a shareholder at the 2009 annual meeting questioned the deals.
“There’s some limit to the amount of those things we should do, but I think we stayed well short of the limit,” Munger said.
Terms on the equity options have shifted over the years. In a 2010 filing, Berkshire said it received $4.8 billion in premiums for 47 contracts. In late 2010, the company unwound eight of those options at the urging of a counterparty, according to Buffett’s annual letter to shareholders. That left Buffett’s company with 39 contracts and US$4.2 billion in premiums. On some of the deals, the parties also have shortened maturities and reduced strike prices, according to Berkshire’s 2009 letter.
The parties on the other end of the deal have remained a bit of a mystery. Buffett said in 2010 that Goldman Sachs Group Inc. was among the counterparties, without naming others. It’s unclear whether Goldman is part of the remaining group. A spokesman declined to comment.
“These derivatives are an example of his creativity,” said James Armstrong, who manages about $700 million including Berkshire shares as president of Henry H. Armstrong Associates. “He saw a mispriced opportunity where Berkshire could make money because people were going to pay more for this insurance than it was going to cost Berkshire.”
Buffett’s equity put options were just a slice of his derivative exposure that’s been winding down. He struck a deal to terminate some contracts tied to municipal bonds in 2012 and paid $195 million in July 2016 to exit the last credit-default agreement.
Berkshire’s energy businesses still use derivatives to manage swings in the price of fuel. Buffett didn’t reply to a request for comment.
Buffett is known for his ability to strike attractive deals with companies seeking safe haven, including taking preferred stakes in Goldman Sachs and General Electric Co. In recent years as preferred holdings were converted and derivative bets wound down, Berkshire has been seeking ways to invest a pile of more than $100 billion in cash and U.S. Treasury bills.
“A lot of this really valuable business is running off now,” Edward Jones’s Shanahan said. “I wish there were more opportunities.”