Option Basics: Using Synthetics to gain exposure to expensive stocks

If you know of the Sage of Omaha, then you know that shares in Berkshire Hathaway are bought for many thousands of dollars. The share price is in excess of USD$87,000. Even the “B” shares are trading at around USD$2,800.

It was an ambition of mine to own a share, so that I could gain access to the annual report for Berkshire Hathaway, which contains many of Mr. Buffet’s musings on the economy, and on the direction he is thinking of taking in the future. For many years the share price was beyond my means

The announcement by the CBOE that Options were to be offered over the “B” shares surprised me, because there have been no dividends offered by the company, even though many of the acquisitions by the company paid substantial dividends.

But the issue of Options means that exposure to another of the “blue chips’  is available at a fraction of the price of the shares.

Now, I am neither recommending that you rush out and buy options in Berkshire Hathaway, nor am I suggesting that you sell them.

What many people are unaware of is that by buying a call option and selling a put option at the same strike price, with the same expiry, will give you a financial instrument, a “synthetic”, that will almost exactly mirror the rise and fall of the stock price itself.

If the share price rises by a dollar, the value of the options will also rise by a dollar. If the share price falls by a dollar the value of the options will fall by a dollar.

This is a “bullish” option strategy that can be used when you believe that a stock will increase in price, but you cannot afford to buy the stock outright.

What even more people are unaware of is that by selling a call option and buying a put option at the same strike price with the same expiry, you create a “synthetic” that is the reverse of the previous option strategy.

If the share price falls by a dollar, the value of the options will rise by a dollar. If the share price rises by a dollar, the value of the options will fall by a dollar.

This is a “bearish” strategy that can be used if you believe that a stock will decrease in price, but you don’t own the stock, and you don’t wish to sell the stock you don’t own, or “short” it.

If you have limited capital using synthetic options can provide exposure to some of the great companies whose share price has climbed so much to be beyond your average investor.

Even with the events of the past few years.