Warren Buffett Lost $132 Million Playing With Financial Weapons Of Mass Destruction

Berkshire Hathaway’s Q1 earnings are out. The massive conglomerate run by Warren Buffett earned a whopping $3.53 billion or $2,149 per share, down from $3.78 billion or $2,302 per share a year ago.
One detail from Berkshire’s filings we’re always interested in is the value of Buffett’s long-term derivative bets on the global stock markets.  In case you forgot, Berkshire had sold put options on the S&P 500, FTSE 100, Euro Stoxx 50, and the Nikkei 225.

Berkshire collected premiums when it sold these options.  Because they are put options, Berkshire is obligated to pay the option buyer should the indices fall below the exercise price.  It’s important to note that these are European style options, which means they can only be exercised at maturity.  As a general rule, the value of these positions increase when stocks go up and vice versa.

This bet was controversial because in his 2002 letter to Berkshire Hathaway shareholders, Buffett dubbed derivative securities as “financial weapons of mass destruction.”

In Q1, the value of these options fell by  million.  Of course, these are just paper losses as Buffett expects to hold them until they expire.

From Berkshire Hathaway’s 10-Q

SEC

Some details from the 10-Q filing:

We have written no new equity index put option contracts since February 2008. The contracts currently outstanding are European style options written on four major equity indexes. Future payments, if any, under any given contract will be required if the underlying index value is below the strike price at the contract expiration date. We received the premiums on these contracts in full at the contract inception dates and therefore have no counterparty credit risk.

The aggregate intrinsic value (which is the undiscounted liability assuming the contracts are settled based on the index values and foreign currency exchange rates as of the balance sheet date) of our equity index put option contracts was approximately $1.6 billion at March 31, 2014 and $1.7 billion at December 31, 2013. However, these contracts may not be unilaterally terminated or fully settled before the expiration dates which occur between June 2018 and January 2026. Therefore, the ultimate amount of cash basis gains or losses on these contracts will not be determined for many years. The remaining weighted average life of all contracts was approximately 6.75 years at March 31, 2014.