Trading & Options · Profile from Trading and Options Research Companion
Berkshire Hathaway Derivatives
The derivatives book that Warren Buffett ran personally inside Berkshire Hathaway, the Omaha conglomerate, from about 2004 to its run-off in the early 2020s. Its centre was 47 long-dated, European-style, at-the-money put options on four equity indices (the S&P 500, FTSE 100, Euro Stoxx 50 and Nikkei 225). They were sold in 2004–08 for $4.8bn of premiums (2010 letter; the 2008 letter gives $4.9bn at the exchange rates of the day). Beside them sat high-yield index credit default contracts ($3.4bn of premiums, $2.6bn of losses paid) and smaller municipal and single-name credit protection. The same man had called derivatives "financial weapons of mass destruction" in the 2002 letter, while he was paying more than $400m to close Gen Re Securities. For a trading book this is the cleanest documented case of a short-volatility seller who survived a crash because of contract structure. Premiums were paid up front, there was no early exercise, tenors ran to 15–20 years, and almost no contract required collateral. At the end of 2008 the puts carried a $10.0bn Black–Scholes liability against $4.9bn of premiums, a $5.1bn mark-to-market loss, yet Berkshire paid nothing and was never forced to sell. Its story turns on survival: the same short tail with daily margin, as at LJM Partners, would have been a different story.
At a glance
- Entity
- Derivative contracts written by Berkshire Hathaway Inc. subsidiaries (Omaha, Nebraska), carried as "derivative contract liabilities" in Berkshire's consolidated statements; not a separate fund or legal entity. Listed parent (NYSE: BRK.A, BRK.B)
- Decision-maker
- Warren Buffett, who wrote that he "both initiate[s] and monitor[s] every derivatives contract on our books" (2009 letter), apart from operating hedges at utilities and the Gen Re run-off
- Type
- Insurance-like seller of long-dated equity-index puts and credit protection; a long-term option seller, not a trader
- Instruments
- Equity index puts (S&P 500, FTSE 100, Euro Stoxx 50, Nikkei 225), European style, struck at the money, 15–20-year tenors; high-yield index credit default contracts (100 names each, about 5 years); state and municipal credit default contracts (from 2008); single-name investment-grade CDS (2008)
- Scale (dated)
- Puts: notional $37.1bn and liability $10.0bn at 31 Dec 2008, intrinsic value $10.8bn (2008 letter; 2008 10-K). Credit: high-yield notional $7.9bn, state/municipal $18.4bn, single-name $3.9bn maximum loss at 31 Dec 2008 (2008 10-K). 251 derivatives contracts at end-2008 (2008 letter), 203 at end-2010 (2010 letter)
- Premiums
- Puts $4.8bn on 47 contracts, 2004–08 (2010 letter); high-yield credit $3.4bn (2010 letter); single-name CDS $93m a year on $4bn of contracts (2008 letter)
- "Derivatives float"
- $8.1bn at end-2008 (2008 letter); ~$6.3bn at end-2009 (2009 letter)
- Collateral
- Most contracts none. ~$550m posted at 31 Dec 2008 (2008 10-K); requirement $1.7bn at the market low (2009 letter, i.e. early 2009); $31m at end-2010; up to $1.1bn more on a downgrade below A−/A3 (10-K, 2010–2018)
- Outcome
- High-yield credit: profit ~$1bn pre-tax (2012 letter). Puts: eight contracts unwound in 2010 at a $222m realised gain (2010 letter); the rest expired between 2018 and early 2023 with settlement payments the 10-Ks call "relatively insignificant" (2020 10-K). Reported put P&L 2006–2022 sums to about +$3.9bn pre-tax (computed from 10-K figures; 2004–05 not included — verify)
- Regulators
- SEC (as issuer), via 10-K disclosure; post-2010 the Dodd-Frank swap rules on new contracts
8 strategic moves analysed
Each one gets a full strategy file in the companion: context, the decision, the financing, what happened, and the lesson.
2002
Gen Re Securities Run Off and the WMD Letter
Closing a strategy (run-off of an inherited dealer book); public warning on derivatives
2004
High Yield Index Credit Default Contracts
New strategy (selling index credit protection for up-front premiums)
2004
Long Dated Equity Index Put Sales
Large position / new strategy (selling long-dated index puts)
2008
Mark to Market Losses and the Black Scholes Critique
Loss and drawdown response (hold, explain, keep the accounting)
2008
Municipal and Single Name Credit Protection
New strategy (credit protection on state/municipal and individual corporate debt)
2009
Collateral Terms Ratings and Dodd Frank
Counterparty and regulatory event / contract modification / decision to stop writing
2010
Early Unwind of Eight Put Contracts
Closing part of a position (negotiated early termination)
2018
Expiries and the Final Run Off
Closing a strategy (holding to expiry; one negotiated termination)