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Many investors are familiar with Buffett’s famous holding of Coca-Cola (NYSE: KO). He began buying shares in 1988. At the time, Buffett said he expected to hang on to this “outstanding business” for “a long time.” And over the ensuing years, he continued to build his position in the iconic company.
Today, Coca-Cola is one of Buffett’s largest holdings. As of February 19, Berkshire Hathaway owned 400 million shares of Coca-Cola, valued at roughly $17.2 billion. That’s nearly a fifth of the company’s equity portfolio.
But what many investors don’t know is the story about when Buffett used options on Coca-Cola.
That’s right. The king of buy-and-hold uses options. More importantly, it’s the way Buffett used options in the case of Coca-Cola — which happens to be a safe, conservative way — that too many investors often ignore…
In 1993, Coca-Cola was trading around $39 per share. Buffett, always the bargain hunter, believed that was too pricey. But the billionaire wasn’t content to passively wait for the stock to fall to his preferred price.
Instead, he decided to use a simple options strategy that eventually earned him $7.5 million before he bought a single share of Coca-Cola.
After deciding he’d be willing to buy shares of Coke at $35 per share, a $4 drop from its current price, Buffett sold enough put option contracts to control five million shares at a $35 strike price.
For those who don’t know, a “put” is an options contract that gives the owner of the stock the right, but not the obligation, to sell 100 shares of the underlying stock at a specified price (known as the “strike price”) within a fixed period of time. For the seller of a put option, it represents an obligation to buy the stock if it drops to that price. And in exchange, the seller collects an upfront premium payment.
In Buffett’s case, he received a $1.50 premium for every put option he wrote with a $35 strike price. At 50,000 put options, this allowed him to collect a cool $7.5 million in the process.
If Coca-Cola fell below $35, the buyers of the options Buffett wrote would exercise those options and sell their shares to him. In that case, Buffett would be obligated to buy Coca-Cola at $35 per share, which is exactly what he wanted to do in the first place.
On the other hand, if the share price of Coca-Cola were to rise during the term of the contract, the owners of the options Buffett wrote wouldn’t be able to exercise them and Buffett, of course, wouldn’t be able to buy Coca-Cola at $35. The options would expire and Buffett would simply walk away with his $7.5 million. Not bad.
And that’s exactly what happened. Buffett earned $7.5 million without buying a single additional share of Coca-Cola, proving that it’s possible to multiply your income from well-known, ordinary stocks. And contrary to what some regular investors might think, it doesn’t have to be difficult.
Simply stated, conservative income strategies like put-selling are one of several examples where many investors just seem to ignore Buffett. And this is a mistake. If you want to be successful in the market, then don’t be content to simply marvel at Buffett’s “genius” — be sure to pay attention to what the man actually says and does, and act accordingly.