Ed. Note: Tomorrow I’m hosting a live event on a topic I’ve never discusses publicly before: it’s an up-close look at how Warren Buffett uses options.
Click here to attend and I’ll save you a seat at my live event where I’ll reveal three live trades you can use to earn $489 during this free event.
“I view derivatives as time bombs, both for the parties that deal in them and the economic system. Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. For example, if you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction, with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration, running sometimes to 20 or more years, and their value is often tied to several variables.”
– 2002 Berkshire Hathaway Annual Report
The quote above is referenced time and time again by the staunchest of Warren Buffett groupies. His “partner” Charlie Munger has exalted similar sentiments. What Buffett followers won’t tell you is how he used these so-called “time bombs” to his advantage over the past several decades. Yes, the same strategies he condemned have led to approximately $5 billion in gains over the past several decades.
Conveniently, his followers ignore the 50,000 short put options he sold on Coca-Cola (NYSE: KO) back in 1993 or the 2.2 million shares of put options he sold on Burlington Northern – Santa Fe (NYSE: BNI) back in 2008. Both stocks he is willing to own, and does, in his own long-term portfolio.
The key to understanding Buffett’s usage of put options lies in his extensive knowledge about the insurance industry.
Buffett famously built his fortune with the help of his insurance holdings. As he wrote in his 2010 letter to shareholders, “Insurers receive premiums upfront and pay claims later. … This collect-now, pay-later model leaves us holding large sums — money we call “float” — that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit.”
What most investors forget (which Buffett certainly remembers) is that options were originally created as a form of insurance. And like Buffett’s standard insurance holdings, selling an option is selling insurance to your counterparty.
Specifically, someone buying a put is hoping to protect gains or cut their losses short.
So when you or Warren Buffett sells a put, you are assuming risk in exchange for premium – just like a property/casualty insurer.
And just like any other insurer, you receive your premiums up front, and pay a claim (buy the stock at the strike price) later. In any event, the premium is yours to keep.
Warren Buffett and Puts on Coca-Cola
Let’s take a look at how Buffett sells puts with a real example on a well-known stock.
In April of 1993, Coca-Cola shares traded for $39. Buffett thought the price was inflated. Based on his analysis he determined $35 was a fair price for the shares.
As a result, he sold roughly 5 million put options at the $35 put strike. If the beverage behemoth fell to $35, the option buyers, otherwise known as the counter-party, would “put” their shares to him for $35. Buffett would be forced to pay $35 a share, but he was perfectly fine with the price. Why? Because he could buy the take at over a 10% discount to the current share price and collect a premium of $1.50 for a total of $7.5 million in premium. This was money he could keep regardless of the where shares of KO fell at expiration.
There is no doubt that Buffett sells put options to buy stocks at a lower cost. As an insurance guru, he also understands the benefits of selling premium.
I have created a report of Buffett’s top 15 holdings and how to buy each holding at discount of 10% or greater using the same type of put options we’ve seen Buffett use for over a decade.
During tomorrow’s live event, I will tell you how to get your hands on this brand new report.
But you need to attend to receive this information.
I’ll also reveal three live trades on current Buffett holdings that could add $489 to your brokerage account live during this event.