How To Take Advantage Of Buffett’s “Win-Win” Strategy
Did you know that Warren Buffett has used a special tool that lets him buy high-quality stocks for up to 10% off market price? Even more amazing, if the tool “fails” to get him a bargain, it will pay him cash for his trouble anyway.
Best of all, any investor — not just billionaires — can use it.
So what is this bargain-hunting, income-generating tool that’s served Buffett well all these years? It’s the same one that my colleague Amber Hestla has used over at Income Trader for years to generate a win-rate of more than 90%.
In a word, options. While around 75% of “buy and hold” investors have never used options before, according to a TD Ameritrade survey, it’s been the billionaire’s secret weapon for reducing exposure to market volatility, preserving capital and even generating income.
Stock Options: How Buffett Pocketed $7.5 Million
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, with more than $22 billion invested in 400 million shares, Coca-Cola remains one of Buffett’s top five largest holdings.
But Buffett is not the type of investor who’ll buy shares of a company at just any price — not even Coca-Cola.
The world’s greatest investor is a bargain hunter. If Buffett likes the company but thinks the price is too high, he may wait until the market “cooperates”. In other words, wait for the price to go lower before he’ll buy shares.
And that’s where options come into play.
In April 1993, Buffett wanted to buy more shares of his beloved Coca-Cola stock. (This story comes form Chapter 34 of Andrew Kilpatrick’s book, Of Permanent Value: The Story of Warren Buffett.)
The problem: Coca-Cola was trading at about $39 a share. That price was too expensive for his taste at the time.
But did the self-made billionaire let his cash sit idle while waiting for a downturn? Not a chance. Buffett used an options strategy that earned him income of $7.5 million — all without buying or selling a single share.
Here’s how he did it. Buffett thought $35 would be a reasonable price for Coca-Cola. So he wrote put option contracts with a $35 strike price for the 5 million shares he wanted to buy.
A put option gives the owner the right, but not the obligation, to sell 100 shares of the underlying stock at a specified price. (This 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. In other words, he was given $7.5 million in cash up front for his trouble. ($1.50 per share x 5 million shares = $7.5 million.)
Two ‘Win-Win’ Scenarios
From here, two scenarios could have played out for Buffett:
1. Coca-Cola’s stock falls below $35 per share by the time of expiration. The buyers exercise those options and sell their shares to him. That way, Buffett buys Coca-Cola at $35, which is precisely what he wanted to do in the first place. He would get the shares for 10% off.
2. Coca-Cola’s stock rises (or stays the same) during the life of the contract. The owners of the options let them expire, and Buffett simply pockets the $7.5 million premium income. ($1.50 x 5 million shares.)
The second scenario is just what happened. Buffett received $7.5 million in instant income for the chance to buy shares of Coca-Cola at $35. That’s the equivalent of a 3.8% yield ($1.50 for each $39 share) over a matter of weeks, without having to buy the stock.
Yes, Buffett could have ignored options and simply waited for Coca-Cola to fall in price to $35 before he bought them. That’s a strategy that many ordinary investors do every day.
But by using put options, Buffett set himself up for success either way. He either gets to buy a quality stock at the discounted price he wants, or, he gets to pocket the premium income as soon as he writes the put contracts.
As we’ve said before, this is about as close to a win-win strategy as an investor can get.
The best part is, you can set yourself up for a win-win in your own investing, too. You don’t have to be a billionaire investing guru to benefit from using this strategy — you just have to act like one.
Want to learn more? My friend Amber Hestla, an options strategist and military veteran, has just finished a report that details how this works. She also answers the most commonly asked questions about boosting income with options.
Amber and her subscribers over at Income Trader have built a track record unlike anything I’ve ever seen… a 90.5% win-rate on their trades. So when it comes to options, she’s my go-to source. If you’d like to learn more about generating income using options, simply follow this link.