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Dec.10

7:27 PM ET

Wednesday, 10 Dec 2008

Warren Buffett's Burlington Northern Stake Rises To Almost 20% After Options-Related Stock Buy

Posted By:Alex Crippen

Topics:Stock Options | Railroads | Warren Buffett

Companies:Burlington Northern Santa Fe Corp | Berkshire Hathaway Inc.

Burlington Northern train
Berkshire Hathaway's stake in Burlington Northern Santa Fe is up to 19.83 percent, after Warren Buffett's holding company bought 3.3 million additional shares on Monday and Tuesday.

It reported a stake of about 18.9 percent as of October 28.

In a filing with the SEC tonight (Wednesday), Berkshire says it bought the Burlington shares at $77 and $80 a share after 'put' options it sold were exercised.

During those two days, Burlington traded between a low of $73.76 and a high of $77.50. Current price: [BNI Loading... () ]

The seller of a put option is paid a certain amount of money to agree to purchase a security at a pre-determined price during a defined time period. In effect, the seller is writing an insurance policy for the buyer of the option, limiting the buyer's potential loss on that security.

If the security goes up in price, the buyer of the option lets it expire and the seller of the option keeps the premium. If it goes down below the insured price, or 'strike' price, then the buyer of the option can force the seller of the option to buy the security at the strike price, even though it is higher than what the security is selling for in the open market. The seller of the option, of course, still keeps the the money it received for selling the option.

In this case, the buyers of Berkshire's put options wanted to be protected if Burlington's stock price wound up below $80 or $77 two months into the future. At the time, the stock was trading around $80.

According to SEC filings, Burlington sold a total of 3,261,111 put options on October 6 and October 8, for between $5.78 and $7.03 each, collecting a total 'insurance premium' of almost $22 million. The options could be exercised on December 8 and December 9.

Berkshire had to pay off on that policy this week by purchasing those 3,261,111 shares on Monday and Tuesday from the holders of the options. Total price: $258.6 million.

On those two days, Berkshire could have bought the same 3,261,111 shares on the open market for between $242.3 million and $251.5 million, using Burlington's intraday highs and lows to calculate the range.

Go to Berkshire Hathaway Portfolio Tracker
That means Berkshire spent between $7.1 and $16.3 million more for the stock than it would have cost at the market price.

But, Berkshire had already collected that premium of $22 million for selling the options in October, so it comes out ahead.

And we assume that Buffett thinks Burlington will eventually wind up higher than the upper $70s, since that's about where he's been buying the stock for over a year now. So he gets 3.3 million more shares at what he would consider a "good" price for the long haul.

In the short-haul, the stock hasn't been doing very well. It's back down to the $70s, about where it was at the beginning of the year, after retreating from a 52-week high of almost $115 in June.

Current Berkshire stock prices:

Class A: [US;BRK.A Loading... () ]