Warren Buffett and the Mispricing of Long-Term Options: Berkshire Hathaway Inc. (BRK.B)

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Unfortunately, the deals that Buffett has made typically aren’t available to investors. Publically available long-term options usually run only a couple of years into the future, which isn’t long enough to allow for the market to run an entire bull-bear cycle and for reversion to the mean to occur.

But one area where long-term options are available is in financial stocks. Thanks to the TARP bailouts, five- to six-year warrants are available on several major banks and financial institutions. For Hartford Financial (NYSE:HIG) and Capital One, the warrants are already in the money, meaning that the current share price exceeds the exercise price of the warrant and limits the impact of volatility-estimate errors on the warrant price.

On the other hand, Citigroup Inc. (NYSE:C) and Bank of America Corp (NYSE:BAC) have warrants with strike prices well above current market values for the shares. With all of their value coming from the time value that volatility estimates generate, warrants on these shares are most susceptible to the mispricing that Buffett discusses.

Take a look
Warrants and options are specialized investments and carry substantial risk. But even so, questions about proper long-term pricing raise the possibility that you can use options to your advantage, making them worth a closer look.

The article Warren Buffett and the Mispricing of Long-Term Options originally appeared on Fool.com.

Fool contributor Dan Caplinger owns shares of Berkshire Hathaway and warrants on Bank of America and Hartford Financial. The Motley Fool recommends Berkshire Hathaway and Goldman Sachs. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, Citigroup, and General Electric.

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