Volatility

This week is out of control.  As a result, there are fascinating new highs and lows, along with some very interesting events.

Stock market volatility is very high right now.  The VIX (see definition at the bottom) measures this volatility and highs in the VIX suggest too many that a bottom could be near.  The following information from the VIX is very interesting (all this information is from Yahoo Finance):

• At this time the VIX is at a high we have not seen for almost 3 years. 
• The VIX has only seen levels higher than the current mark (35.72) twice in the last 18 years. 
  • August 1998 the VIX hit 44.28
  • September 2002 the VIX hit 39.69
• Both, August 1998 and September 2002, signaled distinct lows. 

None of this means we are definitely at a low, as there could be, and probably will be, a little more to come.  However, this suggests we are at least at the beginning of the end if this downturn is similar to the last few.

Buffett

Every piece of business news today will probably be followed with, “Warren Buffett shows confidence in the financial sector by investing $5 billion in Goldman Sachs.”  Per Barry Ritholtz at The Big Picture this is fairly far from the truth due to the very favorable terms Mr. Buffett received:

Let’s look at the details to figure out just how much GS is paying for this capital:

• Goldman Sachs pays a fat dividend to Berkshire Hathaway of 10% on $5 Billion dollars — that’s $500 million per year. And, since this is a preferred, it gets paid out of net income in after tax dollars dollars. Ouch.
• Goldman gets the right to call the preferred at any time at a 10 percent premium. Ouch again.
• Buffett gets $5 billion worth of warrants with a strike price of $115, or about 43.47 million shares. The warrants are good for only 5 years.

If Buffett were to go to the Street earlier today to buy 44 million calls with a $115 strike price (circa 2010), they would have cost him about $1.5 billion dollars. With GS now trading at $135, Buffett’s $5 billion investment is more like $3.5B, in terms of net cost to him. Hence, the 10% interest is more like 14%. 

Doug Kass thinks its an even better deal for Berkshire –  goes further than I do, putting an intrinsic value on the warrants of about $2 billion. That makes Buffet’s net cost $3B — so the effective yield is closer to 17%.  (Ouch)

As you can see, this is a no brainer for Mr. Buffett, as it is unlikely the government will let “THE” investment bank fail during a bailout.  It should also be noted the Treasury Secretary, Hank Paulson, is a former Goldman Sachs alum.

VIX - VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Referred to by some as the fear index, it represents one measure of the market’s expectation of volatility over the next 30 day period.