Warren Buffett’s biggest winner is The Coca-Cola Company (NYSE: KO), according to Berkshire Hathaway Inc. (NYSE:BRK.B)’s latest annual report. Buffett owns 400 million shares of KO and paid an average price of less than $3.25 a share. Today, that stake in KO is worth about $17 billion, which means Buffett has made more than 1,200% on his investment.
Buffett obviously made a great decision when he bought The Coca-Cola Company (NYSE: KO). But he still fought to get the best price possible on his buy. In at least one case, Buffett sold puts to help him get the share price he wanted.
In 1993, Buffett wanted to buy The Coca-Cola Company (NYSE: KO), but at a price that was about 10% below the market price. Rather than overpay, he sold put options at the price he wanted to pay and pocketed nearly $7.5 million in income while he waited for a price correction.
The good news is any investor can sell puts to bring in income after they find a stock they’d like to buy. To understand the idea, we can look at what Buffett did in a little more detail.
The Coca-Cola Company (NYSE: KO) was selling for about $39 a share in the spring of 1993, and Buffett wanted to buy about 5 million shares. Based on his analysis, he was only willing to pay $35 a share. Selling put options allowed him to do just that. He created an obligation to buy 5 million shares at $35 and he was paid $1.50 per share for promising to buy KO later at that price.
Put options give the buyer the right to sell 100 shares of stock at a predetermined price, known as an exercise price or strike price, anytime until the expiration date of the options contract. The investor selling the put promises to buy the shares if the buyer of the put exercises their right to sell the stock. Put options are only exercised when the stock price is in the money, i.e., below the exercise price.
In exchange for their promise to buy the stock later, for more than the market price, put sellers receive a premium from the put buyer. For Buffett, this premium amounted to $1.50 a share for The Coca-Cola Company (NYSE: KO). If the option is not exercised, the seller keeps the premium and earns that amount as a profit on the trade. If the option is exercised, the premium reduces the cost basis. If Buffett was forced to buy KO at $35, his cost would actually be $33.50 a share when the premium is considered.
This strategy can be used with any stock that has options available, which generally includes all large-cap stocks, many mid-cap stocks and a number of ETFs.
How Traders Use It
Traders can use puts to enter long-term positions in stocks. The put premium allows them to generate income while they are waiting for a pullback in a stock they want to own. If the put is exercised, they will be buyers at a price they believe represents a fair value for the stock.