By Andrew Morse
A DOW JONES NEWSWIRES COLUMN
The Oracle of Omaha couldn't have seen it coming. But he did alright anyway.
On Friday, shares of Goldman Sachs Group Inc. (GS) skidded almost 13% after the U.S. Securities and Exchange Commission filed a civil lawsuit charging the investment bank and one of its executives with defrauding investors.
Warren Buffett, however, didn't do anywhere near as badly even though his company, Berkshire Hathaway Inc. (BRKA, BRKB), owns 43.5 million warrants for Goldman shares According to an estimate by Linus Wilson, who teaches finance at the University of Louisiana, Lafayette, Buffett's warrants likely lost just 3.3%.
Buffett's sturdy performance underscores the potentially unexpected movement of options prices during unstable times. The reason: Warrants, which are the right to buy stocks at a predetermined price in the future, behave differently than common stock because volatility--the relative rate at which prices change--is factored into its value. As volatility rises, so does the value of warrants.
"Warren Buffett was smart when he chose to buy the warrants instead of the common stock," Wilson said in an email. "He knew the warrants were very valuable in uncertain times."
Buffett received his warrants as part of a $5 billion deal struck in September 2008 to recapitalize the New York-based bank. He also got preferred shares with a fat coupon of 10%.
After the announcement of the SEC charges--which Goldman denies--investors began unloading shares of the investment bank. By the end of the day, Goldman shares had lost more than $23. Multiplying that loss by the number of shares Buffett's warrants represent suggests a paper loss of roughly $1 billion.
That measure, however, misses an important change in the market. Volatility surrounding Goldman rose to 45% from 26% after the news, according to Wilson, raising the value of Buffett's warrants even as the underlying shares fell in value. Wilson reckons Buffett's investment lost roughly $120 million on paper, far less than the drop in the shares it represents.
It's unlikely that even Warren Buffett is so clairvoyant that he could foresee Goldman's problems when he made his investment in the bank. But he could certainly see the potential risks.
That's why he's also known as the Sage of Omaha.
(Andrew Morse is San Francisco bureau chief for Dow Jones Newswire.)
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