...Even simpler is to ask the question Zvi Bodie did, back in the '90's:
(he seems to have overcome his MIT doctorate)
"If the risk of negative returns decreases over time, why does the cost of long term puts increase?"
(now I know the arguments against Bodie's implication, here's a decent one, here's a counter to the counter, we've got links, baby.)
That's from a scary post titled "Yikes! In Policy Shift, PBGC Turns to Stock Market".
The quick answer to Professor Bodie's question is that the total risk declines (on average the market is up, what, 51, 52 days out of a hundred?), while the chance for a crash/collapse increases.
From Reuters:
Underestimated degree of stock market declineHemi-demi-semi HT: to DealBreaker (they forgot the link) who write:* Berkshire disclosure insufficient despite 2008 demand
* SEC closes review without further comment
* Berkshire shares up 1.7 pct
By Jonathan Stempel and Lilla Zuill
NEW YORK, Aug 13 (Reuters) - Warren Buffett's Berkshire Hathaway Inc (BRKa.N)(BRKb.N) underestimated the risks of falling stock prices to its billions of dollars of derivatives bets, yet still believes it is valuing the contracts fairly.
Berkshire revealed its error in a June 26 letter to the U.S. Securities and Exchange Commission, one of several pieces of correspondence with the regulator about the company's annual report, and made public on Thursday.
It also agreed to SEC demands for more explanation on $1.8 billion of writedowns on stock investments, and $2.7 billion of auction-rate and other municipal debt holdings. On June 29, the SEC said it completed its review without further comment.
The correspondence shows Omaha, Nebraska-based Berkshire, which has close to 80 businesses and ended June with more than $136 billion of stocks, bonds and cash, is struggling to comply with SEC requirements to disclose enough about its finances.
This issue had surfaced in June 2008, when the regulator demanded "a more robust disclosure" of how the insurance and investment company values its derivatives. Buffett did provide some additional disclosure, in what he called "excruciating detail," in his annual shareholder letter in February.
Berkshire, through Buffett's assistant Carrie Kizer, had no immediate comment.
The derivatives contracts are tied to four equity indexes in the United States, Europe and Japan, and are a big reason Berkshire's earnings fell for six straight quarters. That string ended in the April-to-June period as stocks rebounded.
In the June 26 letter, Berkshire's Chief Financial Officer Marc Hamburg told the SEC that last year's 30 percent to 45 percent declines in the equity indexes "are in excess of our volatility inputs.">>>MORE
...We tend to think that these options get overblown, and that the oracle deserves a bit of room on these issues. Seriously, the guy could slip a sexually suggestive comment into a cub scout dinner and no one would even notice. What could a few harmless options do? What more could you want from a finance guy?...
