Warren Buffett’s Berkshire Hathaway and Stock Options

Berkshire Hathaway (BRK.B), the failing textile manufacturing company transformed by Warren Buffet into an extremely successful and diverse conglomerate holding giant, began trading stock options of its Class B shares on June 18th. Its strike prices begin at $2,800, $2,900, $3,000 and $3,100 for the first expiration cycle, ending in March of next year. Its core business being insurance, Berkshire has expanded under Buffet’s leadership to include ownership of a wide range of industry – from vacuum cleaners to regional gas and electric utilities and just about everything in between. Buffet’s notable decision to avoid splitting shares has ultimately contributed to their reputation of high per-share price and low liquidity, alienating the prospect of short-term speculators. A reluctant Buffet eventually created a system of Class B shares with a value of approximately 1/30 of the original Class A shares, allowing Berkshire to function in both short and long-term investment realms. The company has kept even these shares stock options free until its recent announcement.

Stock options shares essentially operate as a contract between the buyer and seller that expires on an agreed-upon date. The buyer gains the right to buy or sell the asset at a specific price before the expiration date, but does not carry the obligation to do so. The seller, however, is obligated to participate in the other end of that transaction. Investors and traders typically use these stock options as either a form of insurance or as a speculative measure. Though Buffet has always favored the concept of simply buying or selling a stock outright, he seems to have made an exception for Class B shares, likely due to the 25% increase in stock options trading over the last year. The stock options will be traded on the Chicago Board Options Exchange, and Berkshire will not profit from their sale.

Because Berkshire is an incredibly expensive stock, there’s a natural desire among investors to gain exposure in a way that, simply put, requires less cash. As purchasing stock options in Class B shares is less risky than fully investing in the $88,000 Class A shares, there is a chance the stock options will be used more commonly than actual stock for investing. Hypothetically speaking, an investor could purchase 100 stock options shares of Class B stock for roughly the same price as 3 or 4 Class A shares, allowing them to potentially gain close to the same level of exposure with fewer risk-based dollars. Beyond being considerably cheaper, these stock options shares allow investors to insure themselves with either downside protection through “puts” (a stock options in which the buyer pays the stock options writer a fee that protects him from a fall in price before the expiration date) or the ability to write covered calls for income. The stock options seller, in turn, generates extra profit if wins the bet that lies within the premise of the put options – namely, that its shares will remain stable through the duration of the stock options‘ existence. For a company like Berkshire, these options can be hit or miss, yet its reputation for maintaining low liquidity (even in its more thinly-traded Class B stock) ensures that results stemming from stock options trading will most likely be positive.

Class B stock options will trade on the CBOE under the ticker “BVQ.”

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[tags] textile, manufacturing, Warren Buffet, insurance, vacuum cleaners, gas and electric utilities, Chicago Board Options Exchange, INTC, Intel Corp. [/tags]