Buffett told Becky last night by telephone that roughly $2 billion of put options on the benchmark S&P 500 stock index have been altered. Changes have also been made to a derivative on a foreign stock index, but he's not saying which one.
He first publicly discussed the changes during a lengthy question-and-answer session with shareholders earlier this month.
The new contracts have a lower strike price but cover a shorter time period.
Like insurance policies, Berkshire's equity derivatives contracts require the company to pay out a "claim" if a particular stock index is below a designated level at a pre-set time in the future.
In return for taking on that risk, Berkshire collects a "premium" payment up front, which it can then invest.
Berkshire's goal: the claims ultimately turn out to be less than the premiums.
Since their strike prices were set to the level of the S&P at the time the 'old' contracts were written, and the index has dropped severely since then, the 'old' contracts would not have reached break-even unless the S&P gained about 70 percent in the next 18 years.
The 'new' contracts become money-makers if the S&P rebounds by just 15 percent over the next 10 years.
It's an easier target to reach, but there's less time available for the S&P to move higher.
That does not necessarily mean Berkshire has taken on more, or less, risk with the 'new' contracts.
Buffett tells us he didn't pay a "dime" in cash to restructure the derivatives, and still feels the odds are favorable that Berkshire will wind up making a profit on both the 'old' and 'new' contracts.
In its first quarter 10-Q, Berkshire reports that it "has written equity index put option contracts on four major equity indexes including three indexes outside of the United States." The contracts expire between 10 and 19 years from now.
Berkshire says in that filing that if there is no change at all in the level of the stock indexes between now and the various expiration dates of the contracts, (a very unlikely scenario), it would have an undiscounted liability of $13.3 billion.
The "notional value" of the contracts on March 31 was $35.489 billion. That is, in effect, a 'worst case' scenario in which the level of each stock index has dropped to zero at the expiration dates of the various contracts.
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