 |
| Warren Buffett uses other people's money to make money. Clever. |
When I was a kid a family friend told me that he once had an opportunity to buy shares of stock in a big company at a really low price. He didn't think he would make any money so he passed on the investment. Within 20 years the stock price had increased 100 times in value. I may be a little fuzzy on the details because it has been so long but we all know someone who is kicking themselves over missed opportunities.
I don't know how to pick great opportunities but I was not surprised to learn that Warren Buffett uses other people's money to make money in the stock market. It's a well-known secret that he owns GEICO insurance and he uses the "float" on insurance premiums to make investments in the stock market.
Buffett's big secret to investing is that he sells options in stock 15-25 years out. I don't know you can price a stock 20 years ahead of the game but he seems to do that a lot. So if you can buy AT&T shares at $33 today and hang on to them for 20 years, maybe there were be a few stock splits along the way, or the price may go up to $50 a share.
If you stick your neck out you can sell options on AT & T where you guarantee to sell the stock at $50 a share in 20 years. People will buy the option from you. Maybe they will pay you $1 per share. You make money just by selling the option, but that obligates you to sell the shares. If the stock price is less than $50 when the options come due you won't have to part with the shares; you can keep the fee you were paid for the option.
That's kind of cool but it's a big risk because what if the stock price surges to $60 in 20 years and you don't have any shares at the time? You have to complete the sale, which means you have to buy the stock at the current price and take a loss. Buffett sometimes takes a loss but he uses the fees from selling options to make other investments.
When I looked at a Website about options trading I got pretty confused by all the language. It's a complicated process. There are Push and Put options (you commit to buy or to sell at a fixed price), and then there are spreads and so on. I thought maybe I could sell some options just to make a little cash but when I checked into eTrade they said I had to have the money to pay for the shares before I could sell them. I guess so many try to sell options that the brokers have to make sure you don't just take the money and walk away.
It's not all candy and roses for the options traders. You have to look at the news to see that options traders can lose a lot of money to fraud and scams. If you don't do your due diligence you could end up buying from the wrong partner and lose a lot of money.
To me it's worth looking at these kinds of investments because Warren Buffett makes money through them. But I did have a little trouble doing the math because it's hard to get your head around the idea that someone will pay you for the opportunity to buy a stock at a certain price without knowing whether that will be a good price.
If you buy shares at a low price, hold on to them for a couple of years, and see the stock price grow, then you could make some extra money by selling options in those shares at a future, higher price that is lower than what you think they will sell for. Say you buy an insurance company stock at $25 a share and two years later it has risen to $30 a share. You could sell an option for ten shares to be sold in five years at $38 a share. That's a nice profit for you even if you have to sell the shares (if the price is below $38 no one will buy the shares). You keep the money from the option deal and then you can sell the shares at market price, as long as you still make a profit over your original investment.
Does it sound crazy? Crazy like a fox. Just be careful and don't let your imagination run wild. I don't think many people get rich doing this. Not that many.
