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BLOG.MYOAKTREEADVISORS.COM: 11/26/12 Covered Call Pick: Berkshire Hathaway Cl B (BRKB)
11/26/12 Covered Call Pick: Berkshire Hathaway Cl B (BRKB)
Berkshire Hathaway is an American multinational conglomerate holding company that oversees a number of subsidiaries that are involved and engage in insurance, food service operations, energy distribution, manufacturing, and finance. Particularly known for Chairman, President, and CEO Warren Buffett, recognized as one of the most successful investors in the world, the company has produced a total return of 76% between 2000 and 2010, as opposed to the -11.3% produced by the S&P 500 over the same time period. The company has two classes of common stock, Class A and Class B. The Class A shares are extremely expensive at over $130,000 per share, while the Class B shares are sold a fraction of the price so the common investor has the opportunity to invest in one of the most highly regarded holding companies in the world.
Berkshire Hathaway Class B shares have a market capitalization of $95.5 billion with 1.09 billion outstanding shares.
BRKB currently pays NO quarterly dividend.
With a beta of 0.84, BRKB currently trades with close to 15% less volatility than the current market.
The choice to use BRKB for a Covered Call Strategy is a big divergence from our normal selections. We have recommended a holding company before in KMI, but the largest detail that will stand out to followers of this blog is the lack of dividend yield on BRKB. One of the primary motivations for using the Covered Call Strategy is to generate supplemental income on dividend stocks for investors whose primary concern is a steady stream of income. In this case, we are using the Covered Call Strategy to take a great investment target like BRKB, and turn it into something that the conservative, income-requiring investor would love to have in their portfolio. In this article we will take you through our process for creating a Covered Call Strategy around BRKB.
The S&P 500 currently has a dividend yield of 2.10%. Ideally we would like to be receiving over 3% on our dividend stocks, but we will use the S&P 500 yield for our minimum annual income target for our Covered Call Strategy on BRKB. To help simplify things, we will be looking at Call Options that are about one year away from expiring. This leaves us with the January 2014 Calls.
Now we need to look at what strike price we would like to choose for our Covered Call. Because we are looking at this strategy as a means to produce income, and because BRKB doesn't pay any dividends, the price of the Call premium is extremely important as it will determine our yield. We also want to take advantage of the expert management of the company and the investment insights they gleam, so we will be taking an out-of-the-money Call to grab some of the potential upside. Below is a table of the first three out-of-the-money Calls on BRKB and the non-annualized yields generated from selling the Covered Call, with the price of $88.16/share of stock:
BRKB January 2014 OTM Call Options
Strike Premium Yield
$90 $4.91 5.57%
$95 $2.76 3.13%
$100 $1.40 1.56%
We can see from these quick calculations that the first two out-of-the-money Calls, the $90 and $95 ones, satisfy our yield requirements as both are over the current S&P 500 yields. We could be selling an in-the-money Call Option, but without a pullback in the stock we would end up selling ourselves short on our opportunities with the stock.
Now we have to decide between the $90 strike price and the $95 strike price. In this decision we are going to go back to our mainstay, which is the macro-environment and the business cycle. We currently see recessionary indicators on the rise which lead us to believe that while 2013 can be a profitable year for the market and the economy, the recovery will be tough, interrupted, and hardly a huge growth spurt. In addition, we are looking at this strategy for a more conservative income-orientated investor. So a measure of safety, which comes in the form of a higher Call premium, is more desirable than a larger upside potential. This is why we prefer to write the $90 Call as opposed to the $95. If you are worried about the stock getting called away, don't be as it will end up netting you a profit, which is hardly something to be concerned over. Selling the $95 call is still a fine strategy for BRKB, but with no offense to Mr. Buffett, we'll stick to the safer side for the moment. That is why we are recommending buying BRKB and selling the January 2014 $90 out-of-the-money Call.
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call)/Stock Price X (Days/Year)/Days to Expiration
(4.91)/88.16 X (365)/417
= 4.87% Static Return
(Call + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(4.91 + 90 - 88.16)/88.16 X (365)/417
= 6.70% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarentee the above, or any, result. All investment decisions should be made based upon individual’s personal investment goals and risk tolerance.