A few weeks ago I wrote an article on how Buffett used derivatives to make money or lower his purchase price for stocks, which you can find here.
Since then I’ve received some very nice feedback, which I greatly appreciate. After a while, I thought since I’ve already done a good amount of work on the topic of derivatives, why not dig a little deeper? Therefore, I took some time and tracked down the details of Berkshire’s use of both put and call options during the acquisition process of Burlington Northern Santa Fe. In this article, I will share with the readers my findings and thoughts.
In my previous article, I attached a picture that shows the exercise of Berkshire’s BNSF put options. What I missed were the premiums and other details of those put options. While going through Berkshire’s SEC filings, I stumbled onto something even more exciting – not only did Buffett used short put options to purchase 5.5 million shares of BNSF, he also used long call options for almost 7.5 million shares. So in total, Berkshire purchased a whopping 13 million shares of BNSF’s stock through the use of derivatives. This is truly astonishing.
Let’s take a look at the details of those options from Form 4s filed with the SEC by Berkshire Hathaway.
Aug 2007 Call options:
Oct 6th 2008 Filing Put options:
Oct 8th Filing Put options:
Oct 10th Filing Put options:
Oct 16th Filing 2008 Put options:
Put Options Summary:
I’ve explained in my last article how short put options worked. Now in terms of the call options, Berkshire bought deep-in-the-money call options. In the money means that your stock option has positive value if you exercise it. For example, if you buy a call option on a stock with a strike price of $10, and the price of the stock is $15, the option is considered to be in the money. This is because the option gives you the right to buy the stock for $10 but you could immediately sell the stock for $15, a gain of $5.
Now, to appreciate how the exercise (or assignment in the case of short put options) of those options lowered Berkshire’s purchase price, I made 4 tables. Table 1 shows the effective purchase price with the use of options. Table 2 shows what Berkshire would have had to pay if they had to purchases those shares on the open market at the exercise date. Table 3 is a comparison of per share purchase prices between those two options. Table 4 shows the total savings from the use of options.
From my calculation, we can tell that Berkshire saved $41 million or 4% , without considering transaction costs, of the market price by effectively using a combination of call and put options. Well 4% may not sound like a lot but if we consider the size of Berkshire Hathaway, getting a 4% of a discount on top of a fair price is quite an accomplishment.
In the end, I want to stress the point I made in my previous article again: Less sophisticated investors should understand that improper use of options can be extremely dangerous and should be avoided entirely if you lack the knowledge and experience in using them. That being said, if used properly, options can be profitable, or can serve you well by reducing purchase prices.