The Difference Between Warren Buffett And You
By Bob Bogda
You don't have to be a billionaire guru to benefit from this
strategy -- you just have to act like one.
You say you wouldn't touch them with a ten-foot pole? You're not alone.
In a 2011 survey, securities broker TD Ameritrade found
that more than three-quarters of "buy and hold" investors have never
bought or sold stock options.
The reasons? "Too risky," according to a third of the respondents.
Twenty-five percent said they "don't need them," and another 23%
admitted they "don't know how they work."
Yes, stock options can be risky, but so is investing in Apple (Nasdaq: AAPL). And, no, stock options are not necessarily "needed" by everyone
-- only those investors who want to reduce exposure to market
volatility, preserve capital and, yes, generate income.
Take Warren Buffett, for example.
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The King of Buy and Hold first bought stock in Coca-Cola (NYSE: KO) in
1988. At the time, Buffett said he expected to hang on to the shares of
this "outstanding business" for "a long time." Today, Coca- Cola is
Buffett's largest holding. As of September 30, the Oracle owned 400
million shares of Coca-Cola, valued at $15.2 billion -- a fifth of his
But Buffett is not the type of investor who'll buy shares of a favored
company at just any price -- not even Coca-Cola.
The world's greatest investor is a bargain hunter. If Buffett likes the
company, but believes its share price is too high, then he'll wait until
the market "cooperates" by correcting lower before he'll buy shares.
And that's where options come into play.
In April 1993, Buffett's beloved Coca-Cola was trading at about $39 a
share (before two splits) -- a price he regarded as too expensive at the
time. But did the self-made billionaire let his cash sit idle while
waiting for a downturn? Not a chance.
Buffett employed an options strategy that in this case earned him income
of $7.5 million -- all without buying or selling a single share. Here's
how he did it...
After determining that $35 would be a reasonable entry point for
Coca-Cola, Buffett wrote 5 million put options with a $35 strike price.
A put is an option contract that gives the owner the right, but not the
obligation, to sell 100 shares of the underlying stock at a specified
price (which is known as the "strike price" -- in this case $35). In
exchange for writing the puts, Buffett in this instance received a
premium of $1.50 a share from the buyers of the puts. (In options, the
premium, or cost, is determined by such factors as the stock price,
strike price and time remaining until expiration.)
If Coca-Cola were to fall below $35 the buyers of the options that
Buffett wrote would exercise those options and sell their shares to him.
In other words, Buffett would be obligated to buy Coca-Cola at $35,
which is precisely what he wanted to do in the first place.
If Coca-Cola instead were to rise during the life of the contract, the
owners of the options wouldn't exercise them. They'd let them expire and
Buffett would simply pocket the $7.5 million premium ($1.50 X 5 million
shares). And that's just what happened -- Buffett received $7.5 million
in instant income for the opportunity to buy shares of Coca-Cola at $35
The best part: You don't have to actually be a billionaire guru to
benefit from this strategy -- you just have to act like one.
My friend Amber Hestla-Barnhart, an options strategist at
ProfitableTrading.com, a StreetAuthority sister site, has just put the
finishing touches on a report that details who should (and shouldn't)
try these strategies and answers the most commonly asked questions about
boosting income with options. If you'd like learn more about generating
income using options, then simply click here.
Managing Editor, StreetAuthority