With a steady nerve and some loose cash at hand, you can master the Warren Buffett Investment Strategy to become the next big thing.
With a net worth of $104 billion, Warren Buffett has proved to be the best investor, without exception. His winning investment strategy makes him the ninth wealthiest person in the whole world.
Interesting. But, how?
Although we know Buffett for buying and holding companies for a number of years, there is more to it.
In addition to just holding the companies, he earns a good deal of profit through selling naked puts.
Understanding Put Options
While Buffett waits for his stocks to hit a sweet spot, he trades options to collect premiums. Take this for instance: Buffett admitted that his company, Berkshire Hathaway, received premiums of around $7.6 billion from 94 derivatives.
To add to it, put options provide a right, not an obligation, to the buyer through which he can sell a specific quantity of security. Moreover, this can be done within a set time limit, i.e., before the expiration date.
For this to take place, the buyer has to pay a ‘premium’ to the seller. At the end of the expiration, either you can settle with nothing or a good sum of money.
Howbeit, Buffett, instead of buying options in the stock market, sells them. Now, you can sell put options in two ways:
- Selling covered call
- Selling naked puts
In selling a covered call, you will be the owner of the 100 shares. With these, you can sell a call. And then, you can collect a premium that will serve as a stock in your account.
For instance, there is a stock XYZ. Now, if you are selling a call by setting the strick price as 50, you are only obliged to sell all 100 shares if it breaks past $100 per share. If it doesn’t, you will get all the shares along with the premium.
Although, it might help you to reduce the risk and earn an extra income for yourself. This is not a part of the Warren Buffett Investment Strategy.
Then, what is? The naked put option.
Warren Buffett and the Coca-Cola shares
Coca-Cola has been one of the Buffet’s all-time favorite stocks. Back when he sold puts for the company, they were $39. The reason being that he wanted to buy the puts for $35 per share.
At that point, Buffett, instead of creating a limit order for the price to hit $35, sold 50,000 puts with $35 strike prices.
As every option has 100 shares, these puts were a bit for 5 million shares—all at his desired strike price of $35.
Consequently, these awarded him with a premium of $1.50 for each share. In total, he earned a handsome profit of $7.5 million.
This Warren Buffett Investment Strategy on how to make money on put options has never failed to win the hearts of the traders. However, with this, there are some risks attached.
Risks of Warren Buffett Investment Strategy
If we still consider the coca-cola trading stock option, there can be two possible risks associated with it. These are:
- Buying stock options, if they go lower than $35, will be an obligation. It can be a cause of inconvenience for you. However, if you wish to hold and hoard the stock for a long time, you are not at a loss.
- The stock might not every time hit your desired strike price. It is not as bad in terms of profit as you still get to take all of your premiums. You can continue with it as long as it hits your required strike price.
While trading stock options, a seller of the put option obligates themselves to own the stock if it hits the decided strike price before expirations. This can be a risky choice to make.
Why does Buffett love selling puts?
The Warren Buffett Investment Strategy explains that if a $100 company is valued reasonably and someone pays him $10 by obligating him to own the company at $100, the break-even point would give him a $90 share.
Here, he likes $100, but if the puts pay off $90, he will hoard them until the value raises.
In place of setting their eyes on the value raises, the short-term traders look up to the expiration date of the contract.
Options vs. Stocks: Which one is better?
Options and stocks are two ways of putting money into the market. However, they offer different profiles and have different risks attached to them.
The difference between stocks and options is very simple. Stocks are high in reward and risk, while options are lower in reward and risk.
Where both of them can be good investments for you, they differ in terms of scenarios.
Here is when stocks are better for you:
- You have prior experience in investing and the stock market
- Your aim is to invest your stock for a long time
- You do not want to keep a close check on the ups and downs of the stock market
Is options trading worth it?
Yes, it is.
Here is when options are worth your money:
- If you want to put a limit on the risk
- You can multiply your money more quickly as you will not have to wait for longer
- It can help you in order to generate income
If you are an advanced investor, the ideal choice for you has to stock. It will help you to develop your portfolio with reduced risk.
Another decent option is to opt for ETFs. It will also allow you to buy a stake in the S&P 500 index fund. And, this is exactly what the legendary investor, Buffett suggests to the investors. He adds that the investors should stay active and keep buying stocks whenever they can.
What are the best stocks for options trading?
Based on the portfolio of Buffet, these are some of the examples of the best stock options to buy:
- The coca-cola company
- Procter & Gamble
- Nike inc.
All of these names have a decent price-to-earnings ratio as well as the return on equity, based on the assessment of Warren Buffett Investment Strategy.
Now, as you know, the right strategy, how to make millions in stocks, should be the next question on your list.
We can divide the procedure into three steps primarily. These are:
Step 1: Starting early
When it settles down to making money with options, time is the strongest weapon of all. The sooner you take off, the more time you have to make money.
Consider a hypothetical situation that you start at the age of 25. As per the S&P 500 index, the average annual return is 9%, let’s say. By the time you are 65, you can have 1.6 million dollars approximately.
Step 2: Diversifying your portfolio
The second step will be to diversify your portfolio. If you want to stay strong in the face of market crashes and multiply your wealth, you should work on it.
You can do this by buying stock options from the market belonging to different segments—for example, some bank stocks, some tech stocks, and some healthcare stocks.
Step 3: Staying consistent
If you wish to time the market, it might not go in your favor. Therefore, stay consistent instead. But, how?
It can be done by setting a set strategy, such as dollar-cost averaging for yourself. In which, no matter what is going on in the stock market, you will invest $500 in it.
These three steps, combined with the Warren Buffett investment strategy, will help you to jump on the bandwagon of trading.
Before you go, we would like to address another important question.
Why do some stocks not have options?
There are some specific regulatory standards that result in not all stocks having options. These include:
- Stocks that have low prices
- Stocks that have low trading volumes
- And stocks that have low market caps.
Now, before you get started with Warren Buffett Investment Strategy, know that there is a risk of losing money involved in it. You can even end up losing all or a lot of your money, if not all.
However, before taking the initial steps, one must be comfortable with all the risks. Here is a final tip: Do not ever stake your whole portfolio just on this investment strategy alone. Make certain that you maintain the right balance between this strategy and other options in the stock market.