Betting on America: Buffett Doubles Down on Derivatives, Ups Stakes in Wells, US Bancorp

Posted May 18, 2009 12:07pm EDT by Aaron Task in Investing, Newsmakers, Banking
Warren Buffett is back in the news as reports emerge of his latest bets.
First, the straightforward: Buffett increased his stakes in Wells Fargo and US Bancorp in the first quarter. The buys are consistent with Buffett’s bullish comments about both banks during Berkshire’s annual meeting in early May.

Second, the complex: Buffett has effectively doubled down on a controversial derivatives bet he placed on the S&P 500, according to The NY Post.

By selling S&P 500 puts in 2007 – just before the market peaked – Buffett’s position declined dramatically in value as the market tanked in 2008 and the early part of 2009. (Puts are bearish option bets; the seller of puts is thus effectively long the underlying asset, in this case the U.S. stock market.)

More recently, Buffett has restructured the bet so that it pays off if the S&P 500 rises 15% from current levels over the next decade. After the market collapse and before restructuring the bet, Buffett needed the S&P to climb 70% over 18 years to break even.

Buffett told CNBC he “didn’t spend a dime” to restructure the bet, but The NY Post claims “the potential risk of loss to Buffet and his shareholders over the next 10 years has actually increased, but only if the markets were to decline from current levels and remain there.”

Indeed, it’s important to note the reported $37.1 billion exposure represents his total exposure, assuming the market goes to zero and the Oracle of Omaha takes no additional steps to hedge himself in the interim. Furthermore, Buffett is essentially betting on America’s long-term prospects and 15% from current levels in 10 years seems like a layup, especially if inflation picks up, as is widely expected.

Still, a lot of people are wondering why Buffett, who famously called derivatives “financial weapons of mass destruction” in 2003, continues to play in this particular sandbox.