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Tuesday, 30 April 2013

Cash: A Call Option With No Expiration Date

Read? Cash: A Call Option With No Expiration Date

Buffett’s View – Cash as a Call

Warren Buffett views cash as a perpetual call option, according to his biographer Alice Schroeder in her tome “The Snowball: Warren Buffett and the Business of Life.” Schroeder says that one of the most important things she learned from many years of studying Buffett and his holding company, Berkshire Hathaway, is that he perceives cash as a call option with no expiration date or strike price. “No expiration date” alludes to Buffett’s patience as a long-term investor, since he is quite content with waiting for the right opportunity to come along. “No strike price” implies that Buffett generally does not publicly specify a price level for a stock or index at which he would be willing to invest. Instead, he tends to invest at levels where he is confident of adding shareholder value.

Buffett’s perception of cash can also be summed up in one of his aphorisms -
“Cash combined with courage in a crisis is priceless.” As Schroeder explains in her book, Buffett’s best opportunities have always arisen during periods of crisis and uncertainty, such as after the 2001 dot-com bust and corporate fraud epidemic (Enron, WorldCom, etc.). While others may lack the insight or resources to invest heavily during such times, Buffett went on a shopping spree in 2002 through Berkshire Hathaway, making investments and scooping up companies in a number of sectors. Buffett also famously urged investors to “Buy American” equities in an op-ed in the New York Times on October 16, 2008, a month after the bankruptcy of Lehman Brothers, when global stock markets were in free fall.

Can the Average Investor Benefit?

To benefit from this view of cash as a perpetual call option, an investor needs to have two prerequisites: access to a substantial amount of cash, and an innate sense of market timing. Savvy investors who possess both have generated a great deal of wealth by investing in stocks – or increasing their allocation to equities – at market lows.
But such investors are likely to be the exception rather than the norm, since not many people have the luxury of access to substantial amounts of cash on demand, and market timing is not easy to put into practice.
However, there are periods when the average investor may benefit from holding a relatively large cash balance, rather than being in a hurry to put this cash to work. The most common instance is when asset prices are trading at or near record highs, because at such times, the downside risk is likely to be greater than the upside potential.

Holding cash has an opportunity cost, which is equal to the difference in returns between other better-performing assets and the minimal return on cash. For example, if you decide to stay in cash and opt for a certificate of deposit paying 1% annually instead of investing in an equity index that subsequently returns 10%, your opportunity cost would be 9%. But if the equity index returns 2%, your opportunity cost is only 1%.

Uncle8888 is learning too. Patience, patience, patience .....

Why Uncle8888 keep repeating like an insane person?

In investing, Your Account Size Really Matters!

Read? How to become rich in stocks??? (14)

This opportunity cost should be viewed as the option premium paid for staying in cash, or the cost associated with having cash as a call option. The “cost” of such call options fluctuates over time. It is low when investment opportunities are few and upside is limited, at which time investors are better off holding cash as they await better entry levels. But at other times – typically during the uncertainty that reigns after a market crash – when downside is limited and investment opportunities are both abundant and compelling, the opportunity cost of staying in cash is too high. At such times, investors should consider aggressively deploying their cash holdings into assets that offer potentially higher returns.


  1. CW,

    Thumbs up!

    You have a head start in patience; you into fishing!

    "Sell side" articles and speeches would of course say the opposite ;)

  2. Is this what Crisis Investment is all about?
    But you still must buy the "right" stocks.


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