"My life has been a product of compound interest." Warren Buffett.
Warren Buffett is the most successful investor of all time, and he has no secret about how he got there. The power of compounding has been essential to Berkshire's success, and both Munger and Buffett never made any apologies for it. Compounding has been central to their success, but compounding requires time.
Speeding it up may be preferable for some investors, and that is who this trade is for. However, as a disclaimer, if you don't understand theta decay, the Greeks, and options trading, then this isn't for you. Punk Rock Trades are for sophisticated investors who understand the risks of our sophisticated trades.
At Punk Rock Traders, some of our recommended trades are more prescriptive, like our recent $VIX shorts and $NVDA long strangle. However, some are looser and more principle-based. The individual investor's preferences and needs may affect where and how you want to position, so in this piece, we give the philosophical underpinning of the trade and how to implement it, but we leave the specific to our base of highly informed market participants.
Of course, there is a little bit of a conundrum for Berkshire owners, though. The stock doesn't have a dividend. Of course, the conglomerate owns many stocks that do, but compounding your Berkshire Hathaway shares won't be possible without getting a little fancy.
It is understandable why Berkshire Hathaway doesn't pay a dividend. If you're making a choice between returning capital to shareholders and giving it to the most prolific stock manager of all time, the firm's board can be forgiven for thinking the latter is a better use of scarce resources. However, you don't have to sacrifice your ability to compound on Berkshire stock.
You can effectively create a synthetic dividend by conducting the wheel trade. It's important to note that this is not a short-term trade but rather a long-term strategy that requires maintenance and consistency to beat Berkshire's return over time. Obviously, if you can achieve extra compounding on the stock, it is very in line with the spirit of Munger and Buffett to get that extra premium if you can.
While the term synthetic connoted inferiority in other contexts, the truth is, if you plan well and avoid unnecessary tax consequences, a synthetic dividend is economically superior to a real one. This is because management is not required to forego investment to compensate shareholders. You're getting that money yourself, and other investors not engaged in the strategy won't get it.
As you can see, the wheel trade starts out with a cash-covered put, and then once assigned and long the stock, you can gain more income with covered calls. If you keep this position self-contained, you can really achieve compoounding over time. You always get to keep the premiums you sell, so if you keep growing the position and wheeling between cash-covered puts and covered calls, you can materially outperform the stock alone over time.
This options strategy is neutral to slightly bullish, and Berkshire's recent major sale of some of its top positions has given it a larger cash position than it has had in recent history. All else being equal, this should reduce the volatility a bit for a stock that is already low beta. This reduced volatility can really increase the effectiveness of short options strategies that benefit from theta decay. When the VIX is low, theta decay strategies usually do well.
The following reasons suggest to me that the trade will be profitable, given its characteristics:
Inflation has largely receded, and the Fed will soon begin cutting rates. This Goldilocks economic backdrop is good for trade.
We just had one of the largest volatility events ever and the quickest crash ever. I think that front-loaded some volatility, which explains the $VIX in the $14 handle today after very recently being in the $60s.
Berkshire has been cautious and has $276 billion in cash, which was 46% more than in March 2024. This should reduce the beta of the stock.
I think the relatively subdued volatility we can expect from the stock can make it a particularly favorable environment for a strategy that benefits from theta decay
If you create this as a standalone position and keep investing the proceeds only in Berkshire stock when you are assigned, you will achieve synthetic compounding. This is a way to accelerate a stock's returns that is meant to be very safe and held for the long term. You can significantly mitigate your risk in the stock in the long term if you employ this strategy.
Given the favorable environment, both for the stock and in the wider economy, I think this is a winning strategy. But remember, it requires long-term commitment and steady maintenance. Given the current environment, you can afford to be aggressive with strikes. However, part of the benefit of this trade is that you can customize it to your specific needs.
