2008: How does Berkshire use options to enter or exit a position?

AUDIENCE MEMBER: Good morning. I’m Joe Hutchin (PH), a shareholder from Culver, Indiana.

Could you please comment on how you use stock options when trying to enter or exit a position in a public company?

WARREN BUFFETT: Yeah. We’ve — I think there’s one time we sold a put on Coca-Cola with the idea that, if it got exercised, we were very happy to own more Coca-Cola. It didn’t get exercised. We would have been better off if we had just bought the stock.

Usually, if you want to buy or sell a stock, you should buy or sell the stock.

And using an option technique to buy a call on a stock instead of buying the stock outright with the idea that you get it a little cheaper that way means that about four times out of five you’ll be right and the fifth time the stock will have moved earlier and you’ll have missed, you know, the transaction you wanted to have.

And so we virtually have never used options as a way to enter a position or exit a position, and I would doubt very much if we do.

We’ve used — we’ve sold these equity — long-term equity put options that were described in the press release yesterday and were described in the annual report, but that’s a different sort of thing.

If we want to buy something, we’ll just start buying it. And if we want to get out of it, we’ll start selling it. And we won’t get involved in any fancy techniques.

Charlie?

CHARLIE MUNGER: Well, if I remember right, you wrote a letter when the public authorities were deciding whether we should have option exchanges for stocks. And Warren was all alone at that time, and he wrote a letter saying that he didn’t think it would do any good at all for the country to throw out the margin rules in this fashion.

I’ve always thought that Warren was totally right. We — it’s — the idea of turning financial markets into gambling parlors so the croupiers can make more money has never been very attractive to us.

WARREN BUFFETT: Yeah. (Applause.)

WARREN BUFFETT: Yeah. It’s very interesting to me when I talk to these MBA students. One of them from the University of Chicago, the very first question I got a few years ago, he says, “What are we being taught that’s wrong?”

I love questions like that. I have to plant them in the future.

The amount of time spent at business schools — maybe it’s a little less now — but teaching things like option pricing and that sort of thing, it’s totally nonsense.

I mean, you need two courses in a business school: one is how to value a business, and — from the standpoint of investments — how to value a business and how to think about stock market fluctuations.

But the idea that you would spend all of this time with formulas — but the problem, of course, is that the instructors know the formulas, and you don’t when they come, and so they’ve got something to fill the time explaining to you.

And, you know, it is no fun if you — I mean, if you were teaching Biblical studies, you know, and you could read three or four of the most important religious tomes forward and backward in five different languages, you would hate to tell somebody that it comes down to the Ten Commandments. I mean, any damn fool can do that.

So there’s a great desire of the priesthood in finance to want to teach the things that they know and you don’t know and that they spent a long time learning and that maybe requires a fair amount of mathematics.

And it really has nothing to do with investment success. Investment success depends on buying into the right businesses at the right price. And you have to know how to value businesses, and you have to have an attitude that divorces you from being influenced by the market.

You want the market there, not to influence you, you want it there to serve you. And that requires a mindset, which goes back to an earlier question, and it’s a mindset that’s described quite well in Chapter 8 of “The Intelligent Investor.”