Berkshire Hathaway Inc. (BRK.A), Goldman Sachs Group, Inc. (GS): Is This Buffett’s Secret to 50% Returns?

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Finally, the strategy was also inspired by the more classic view of Buffett as a value investor looking to pick up bargains. The reason this strategy had an opportunity to profit was because it left the downside risk wide open, and in fact magnified it. That’s a crazy thing to do in an options strategy, yet it was a little less crazy if there was good reason to believe the underlying stock was undervalued by the market.

What went wrong?
In spite of the fact that the overall strategy worked out over the course of a year, it wasn’t consistently smooth sailing. I did have to manage around a handful of margin calls — including one where Hurricane Sandy shut down the market, but not the timer that determined when I had to make good on the call.

Additionally, this strategy requires regular maintenance to roll forward the strangle positions. On two occasions, the combination of a down stock and evaporated time values prior to expiration meant that I had the shares put to me before I could roll forward the contracts. As a result, I now own shares of freight company Arkansas Best Corporation (NASDAQ:ABFS) and gold miner Harmony Gold Mining Co. (NYSE:HMY) .

While Arkansas Best Corporation (NASDAQ:ABFS) has since recovered, in large part thanks to merger talks, Harmony Gold Mining Co. (NYSE:HMY) remains weak. Some of that weakness can be traced to the falling price of gold, but much of it has to do with the miner’s internal problems, including violence and labor strife at a key South African mine. Time will tell whether Harmony Gold Mining Co. (NYSE:HMY) gets its operations in order, but in the meantime, it certainly shows just how real the downside risks are in this strategy.

In a Foolish nutshell…
To put it all together, this strategy did beat Buffett’s 50% annual returns target for one year, and while it’s inspired by Buffett, it’s almost certainly not the way he’d go about guaranteeing such returns. The risks are huge, the upsides capped, and the reliance on the market behaving just right is too large to come anywhere close to a reliable market-trouncing strategy.

It was certainly fun and profitable to try to figure out how Buffett could guarantee 50% annual returns, but for now, that secret remains Buffett’s.

The article Is This Buffett’s Secret to 50% Returns? originally appeared on Fool.com.

Fool contributor Chuck Saletta owns shares of Arkansas Best Corporation (NASDAQ:ABFS) and Harmony Gold Mining Co. (NYSE:HMY).  Chuck also has options positions in Arkansas Best and Harmony Gold. The Motley Fool recommends Berkshire Hathaway Inc. (NYSE:BRK.A) and Goldman Sachs Group, Inc. (NYSE:GS). The Motley Fool owns shares of Berkshire Hathaway Inc. (NYSE:BRK.A).

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