Investing in derivatives (options) the Monday Morning Millionaire way

Writing in Berkshire Hathaway’s 2002 annual letter, the justly renowned “Oracle of Omaha”, Warren Buffett stated that derivatives (options, that is, puts and calls) are “financial weapons of mass destruction.” Nevertheless, Berkshire Hathaway has some major derivatives positions. How can that be? Well, Buffett once defined risk as not knowing what you are doing. By that definition, the Berkshire Hathaway position is not risky.

Here is one example of what Buffett is talking about. More than 20 years ago, investing in derivatives resulted in a $1.7 billion loss and bankruptcy of California’s Orange County. Some 3,000 public employees lost their jobs and services were reduced. Merrill Lynch & Co., the broker involved, made millions in fees, not surprisingly.

There are other examples. Long-Term Capital Management, with some of Wall Street’s major figures as well as two Nobel Prize-winning economists, needed a bailout of billions by more than 10 financial institutions in order to prevent market panic and collapse of the entire financial system. Much of their portfolio was made up of derivatives but the company was too big to fail.

The Monday Morning Millionaire Program way of investing in derivatives is safe. For interested members, the program recommends the following: