In the three trading days since Berkshire Hathaway (BRK.B) reported excellent Q4 2024 and full-year earnings, BRK.B stock has gained over 3% on the news. While that might not seem like a big deal compared to high-growth businesses such as Nvidia (NVDA), it's a decent-sized move for Warren Buffett’s holding company.
Investors are concerned about the level of cash Berkshire holds--it ended 2024 with $334.2 billion in cash, up from $325.2 billion at the end of the third quarter--many suggesting the Oracle of Omaha is less than optimistic about the near-term economic prospects in the U.S. and elsewhere.
In his annual letter to shareholders, Buffett said the rising level of cash had everything to do with valuations, at least as it relates to moving some of it into equities. As for M&A, Buffett was quiet on the subject. Impatient investors won’t be happy about the silence.
If you’re a patient investor, owning Berkshire stock remains one of the best defensive/offensive moves you can make.
In yesterday’s unusual options activity, Berkshire had two puts with Vol/OI ratios of 1.24 or higher expiring in seven days or more. They set up nicely for a bull put spread if you're interested.
However, before I get into the unusual options activity, I’ll consider some of the finer points of 2024’s results.
Insurance Continues to Drive the Berkshire Bus
Berkshire generated 47.44 billion in operating earnings in 2024, 27% higher than in 2023. The company's operating earnings from insurance underwriting were $9.02 billion, 66% higher than a year earlier, accounting for 19% of its operating earnings overall. That’s up from 14.5% in 2023.
Buffett said something about its insurance business in the annual shareholder letter.
“Our insurance business also delivered a major increase in earnings, led by the performance of GEICO,” Buffett wrote.
“In five years, Todd Combs has reshaped GEICO in a major way, increasing efficiency and bringing underwriting practices up to date. GEICO was a long-held gem that needed major repolishing, and Todd has worked tirelessly in getting the job done. Though not yet complete, the 2024 improvement was spectacular.”
Buffett can sometimes be effusive in his praise, but this is very encouraging news if you are a shareholder or are considering buying its stock. GEICO was falling behind Progressive (PGR) in the property and casualty arena. It needed a reboot.
In August 2023, I recommended Progressive stock to Barchart readers. Its shares have more than doubled in the 18 months since. Berkshire stock is up 40% over the same timeframe.
The other positive is the 43% increase in the insurance business’s investment income in 2024. Berkshire generated $13.67 billion in investment income last year, a large portion of which came from short-term Treasury bills bought for its cash hoard.
Usually, you want to take the increases and decreases in investment income with a grain of salt. Successful insurance companies underwrite well and the investment income is the cherry on top.
However, with cash expected to remain elevated in 2025, ongoing growth in investment income this year and possibly next should be doable.
The biggest negative in 2024 is that 53% of its 189 operating businesses reported declining operating earnings in the past year. However, if you’re a glass-is-half-full person, it’s an opportunity for Berkshire to reduce that percentage in 2025 and beyond.
Finally, most people think Todd Combs and Ted Weschler, Buffett’s investment lieutenants, sit behind a computer screen all day picking stocks. However, stories such as the one above suggest otherwise.
The talent bench at Berkshire remains deep. Now onto the put options in question.
The Put Options in Question
As I said in the introduction, Berkshire had two unusually active options in yesterday's trading. Both were put options.
A bull put spread is when you sell a put option and buy another put at a lower strike. Typically, they have the same expiration date, but that doesn’t mean you couldn’t do one for yesterday's two unusually active put options.
So, in the above example, you sell the Jan. 16/2026 $500 put expiring in 324 days, generating $26.30 in premium (bid price). You also buy the Dec. 19 $440 put expiring in 296 days for $9.95 (ask price) for a net credit of $16.35. That’s the maximum profit. The maximum loss would be $43.65 [$500 strike - $440 strike - $16.35 net credit].
Generally, you want to keep the strike price differential to a smaller number than six as is the case here. However, the bet doesn't seem as bad if you look at the two puts individually.
This is the put you sell for income. You want it to expire out of the money. It’s got slightly less than a 50/50 shot at doing so. At the moment, it’s in the money by 1.19%.
This is the second put that you buy. You want it to expire out of the money. The OTM probability is 73.56%, suggesting that the buy part of this bull put spread is more likely to be successful.
There are problems with this bull put spread.
First, the maximum loss is about 2.7x the maximum profit, which suggests that the risk/reward isn’t completely working in your favor.
Secondly, the different expiration dates, albeit only 28 days, make following the bet much more difficult for several reasons that I won’t discuss. Suffice it to say that this isn’t a move for someone who’s not risk-tolerant.
The Bet to Make
I’ll separate the two unusually active put options to determine this, starting with the $440.
In this instance, it depends on your aim: to generate the highest net credit or profit potential, or the most income while lowering your risk. If it’s the former, the $550 put is the play. If it’s the latter, it's $490, because the maximum loss is the lowest of the three, while the profit probability is the highest.
For the Jan. 16/2026 $500 put, you have many possible puts to play ranging from $380 to $490. I won’t show all of the puts. Again, it’s a matter of your desired outcome.
If you want a higher maximum profit, the $380 put has a 57.8% profit probability, but the maximum loss is $98.35, 4.54x the maximum profit. Meanwhile, the $490 put has the lowest maximum loss of $7.55, just 3.08x the maximum profit.
If it were me, I’d look for something between 4.54x and 1.40x, somewhere around 3.0x. That would be selling the $490 put and buying the $440 at 3.27x.
Or you could buy Berkshire stock and call it a day.
