Option investors who buy and sell puts and calls for a fraction of the price of actual shares in blue chip companies like McDonald's Corp and Caterpillar Inc will soon get a chance to do the same with Berkshire Hathaway Inc
Investor Warren Buffett's plans to conduct a 50-for-1 stock split of Class B shares in his Berkshire holding company will make trading in the company's stock much more attractive for those who have long found it too costly and is expected to boost activity in the options as well.
The split comes in connection with Berkshire's $26 billion deal to buy railroad operator Burlington Northern Santa Fe Corp
Berkshire is one of the highest-priced shares listed on the New York Stock Exchange. A lower-priced stock should beckon more option investors as the option contracts are adjusted to reflect the split.
What I have seen in the past in general when a stock splits is that the share price can rally and option volatility increases, said Dan Sheridan, president of Sheridan Options Mentoring, an educational options firm.
Buffett has never split Berkshire stock in his Omaha, Nebraska insurance and investment company. The class carries a high price, lately at $3,276 on the New York Stock Exchange.
Shareholder approval would increase the number of Class B shares that the company is authorized to issue to 3.23 billion from 55 million shares.
Once approved, stock volume is expected to increase in the share class. In the last 30 days, about 24,000 shares in the Class B shares have traded daily, according to Thomson Reuters data. That's a paltry figure, but it still dwarfs the Class A shares, which sport daily volume in the hundreds and trade at about $98,000 each.
Options volume is also thin. From November 9 to December 9, the average daily option volume for Berkshire Class B shares was 115 contracts, according to the Options Clearing Corp, compared to an average of 106,409 contracts per day in JPMorgan Chase & Co in the same period.
MORE OPTIONS FOR OPTIONS TRADERS
Berkshire, because of thin volume, sports a wide bid-ask spread in its options. Traders tend to prefer more affordable stocks, and the split should shift the Class B shares into the price range of stocks such as Johnson & Johnson and Wal-Mart Stores, where there is more options activity.
More volume would lead to tighter spreads, the difference between the bid and ask price for an option.
The market quality defined by a narrowing of bid and spreads and improved liquidity or volume should be better than it was for Berkshire before the split, said Sheridan.
According to Steve Quirk, managing director of trading at TD Ameritrade the spread on the March $3,300 Berkshire call strike was $32 on Friday.
By contrast, JPMorgan's March at-the-money $41 call bid-ask spread was about two cents wide, which is far more tradable for a retail investor, Quirk said.
Once the company splits the stock, officials on the five U.S. options exchanges that list them would meet to adjust the terms of the options contracts.
For example, an owner of a Berkshire Class B call option at the $3,300 strike could potentially end up with 50 contracts at the much lower $66 call strike. The strike's open interest is expected to also multiply by 50 times.
The split creates interesting option strategies for those who believe Berkshire shares will rally after the split, and investors betting on that may look to play the stock sooner.
Investors who cannot afford to buy shares at about $3,300 each could execute a similar trade with call options, said Victor Schiller, president of Investors Observer, an investment research firm in Charlottesville, Va.
You could buy a March 2010 $3,200 Berkshire call for a premium of around $200 per contract, Schiller said.
After the stock splits, the option contracts will be adjusted and as investors potentially crowd into the stock you could sell those calls at a profit. The risk is that the stock could drop for a variety of reasons, he said.
Another lower-cost and less risky strategy might be to sell the March $3,400 call to partially fund the purchase of the lower strike $3,100 March call for a $180 debit per contract.
If the stock goes up by 4 percent by March expiration an investor could pick up over a 60 percent profit, he said.
A shareholder meeting to approve the split is scheduled for January 20, according to a regulatory filing.
(Reporting by Doris Frankel)