Barron's - USA (2020-08-03)

August 3, 2020 BARRON’S M5

THE STRIKING PRICE

Warren Buffett recently doubled down on Bank of

America shares. His actions reinforce the notion

that it is better to buy fear than to hedge fear.

Pick Your Play: Buy Like

BuffettorPayforHedges

A

common conversation among

investors these days is whether

they should sell their stocks and

move to cash, or hedge against a

potential decline.

So many people have made so much

money in such an unusual time that the

market resembles an ATM. Put a dollar in

today, and in a minute, hour, week, or

month, it magically grows into something

more. Yet the real world is odder and odder.

In major U.S. cities, people with different

political views dress up like Rambo, arm

themselves as if they are headed to war,

and face off against each other as even

more heavily-armed federal agents emerge

from the sidelines to maintain the peace,

however that may be defined.

Meanwhile, the U.S. has been hobbled by

the coronavirus, and the federal govern-

ment is again about to flood the economy

with trillions of dollars to prevent economic

and financial catastrophe. And for that, the

stock market continues to be carried higher

by a handful of stocks, includingAlphabet

(ticker: GOOGL),Apple(AAPL),Ama-

zon.com(AMZN),Microsoft(MSFT), and

other tech names.

Strategists who were helping investors

find stocks to profit off Covid-19-triggered

changes in working and living are now in-

creasingly dealing with clients wanting to

hedge their portfolios. Yet everyone is dis-

covering that hedging is expensive, perhaps

too costly if the stock market fails to lose

25% or more of its value.

As this hedging conversation occurs, one

of the world’s most admired investors has

finally revealed what’s on his mind. Warren

Buffett’sBerkshire Hathaway(BRK.A)

bought $1.73 billion ofBank of America

(BAC) stock from July 20 through July 30,

paying an average price of $24.24 a share.

Berkshire now holds 1.02 billion BofA

shares worth more than $25 billion, making

it Berkshire’s second-largest equity holding

behind Apple.

Buffett’s decision to buy a weak stock is

noteworthy when so many others are talk-

ing about hedging. In fact, it’s hard to recall

a time when he has not chosen to make ma-

jor purchases when the market was weak.

Buffett’s actions reinforce the notion that

it is arguably better to buy fear than to

hedge fear. Aside from the expense of hedg-

ing, which can depress portfolio returns,

hedgers have to be right on the timing. The

more time packed into the hedge, the more

expensive the hedge.

While it sounds catchy to describe the

stock market as having become “antifrag-

ile”—able to withstand social and financial

chaos—it’s truly difficult to have such confi-

dence about something as diverse and com-

plicated. Instead, it’s better to focus on

stocks, which are more knowable.

In that spirit, let’s reconsider Bank of

America, a company we have championed

since the darkest days of the financial cri-

sis, well before Buffett became its most fa-

mous shareholder. When it seemed as if the

bank might go under, we championed it

and CEO Brian Moynihan, and encouraged

investors to build positions when the stock

was trading close to zero.

Now, after more than a decade, Bank of

America is in a very different place, though

the shares are again weak as the Federal

Reserve once more reduces rates to support

a wounded economy and financial system.

With the stock at $24.88, investors could

sell BofA’s September $25 put option for

$1.50. So far this year, BofA’s stock is down

29%. Over the past year, the stock is down

15%. During the past 52 weeks, it has

ranged from $17.95 to $35.72.

If the stock is below the strike price at

expiration, investors buy the stock. Should

the stock be above the strike price at expi-

ration, investors keep the put premium.

The key risk is the stock falling far be-

low the strike price, obligating investors to

buy shares at the higher strike price. Even

if that happens, don’t fret. Remember what

Buffett does: He uses weakness to his long-

term advantage.B

By Steven M. Sears

Equity Options

CBOE VOLATILITY INDEX

VIX Close VIX Futures

10

30

50

70

90

SO ND J FMAMJ J

Daily Values Source: CBOE

THE EQUITY-ONLY PUT-CALL RATIO

Put-Call Ratio S&P 500 Index

45

70

95

120

145

170

195

220

245

270

295

SO ND J FMAMJ J

Source: McMillan Analysis Corp.

SPX SKEW

Implied volatility %

7

8

9

10

11

12

13

14

15

16

17%

SO ND J FMAMJ J

Source: Credit Suisse Equity Derivatives Strategy

NDX SKEW

Implied volatility %

8

9

10

11

12

13

14

15

16%

SO ND J FMAMJ J

Source: Credit Suisse Equity Derivatives Strategy

Skew indicates whether the options market expects a stock-market advance or decline. It measures the difference

between the implied volatility of puts and calls that are 10% out of the money and expire in three months. Higher

readings are bearish.

Week'sMostActive

Company Symbol TotVol Calls Puts AvgTotVol IV%ile Ratio

Eastman Kodak KODK 728953 158187 570766 300 100 2429.8

MediciNova MNOV 24772 11203 13569 28 97 884.7

Vocera Communications VCRA^63212367395421272 29.8

Alector ALEC 8630 7291 1339 416 8 20.7

Qurate Retail QRTEA 46547 45307 1240 2396 89 19.4

Marathon Patent MARA^409343885820763092100 13.2

Spectrum Pharmaceuticals SPPI^1221310017219694084 13.0

US Xpress Enterprises USX 4676 4273 403 384 68 12.2

Consolidated Communications CNSL 2395 2184 211 204 61 11.7

Pacific Ethanol PEIX^146551303916161280100 11.4

Sohu.com SOHU 16091 9723 6368 1484 95 10.8

Tenable TENB 9311 4056 5255 864 45 10.8

Genocea Biosciences GNCA^1150383173186111274 10.3

A10 Networks ATEN 4073 3708 365 420 48 9.7

Adamis Pharmaceuticals ADMP 48772 48421 351 5224 68 9.3

F5 Networks FFIV^292591741711842315262 9.3

Kandi Technologies KNDI 98318 74651 23667 11868 100 8.3

ADMA Biologics ADMA 32416 30272 2144 3972 98 8.2

Flexion Therapeutics FLXN 4450 4262 188 576 87 7.7

Brunswick BC^18503166831820258880 7.1

Thistableofthemostactiveoptionsthisweek,ascomparedtoaverageweeklyactivity–notjustrawvolume.Theideaisthatthe

unusuallyheavytradingintheseoptionsmightbeapredictorofcorporateactivity–takeovers,earningssurprises,earningspre-

announcements,biotechFDAhearingsordrugtrialresultannouncements,andsoforth.Dividendarbitragehasbeeneliminated.In

short,thislistattemptstoidentifywhereheavyspeculationistakingplace. Theseoptionsarelikelytobeexpensiveincomparisonto

theirusualpricinglevels.Furthermore,manyofthesesituationsmayberumor-driven.Mostrumorsdonotprovetobetrue,soone

shouldbeawareoftheseincreasedrisksiftradinginthesenames

RatioistheTotVoldividedbyAvgTotVol.IV%ileishowexpensivetheoptionsareonascalefrom0to100.

Source:McMillanAnalysis