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OF ALL THE HONORS AND adulations bestowed upon Warrren Buffett, one has eluded him these many years.
His company's stocks, Berkshire Hathaway (ticker: BRKA) and the so-called Class B Baby Berkshires (BRKB), have never been included in the Standard & Poor's 500 index. The index is the definitive benchmark of the U.S. equity market; its 500 stocks rank among the world's largest and most highly regarded companies.
But Berkshire's recent acquisition of the Burlington Northern Santa Fe (BNI) railroad, which is a component of the S&P 500, could lead to index inclusion for the Baby Berkshire shares. Acquiring companies are often added to the index.
At about $101,000 a share, Berkshire's A-shares are too expensive and trade too infrequently to be included in the S&P 500. But if Baby Berkshire stock, recently priced around $3,380, splits 50-for-1, as proposed by management and subject to shareholder approval, the shares could be added to the index, Jefferies & Co. is telling clients.
If this happens, Jefferies' quantitative strategists have calculated that index funds and other asset managers that track the index would buy $4 billion, or 60 million shares, which equals about 38 days of trading volume.
The forced buying typically creates lots of action in the stock and options market. To take advantage, aggressive investors can consider buying Baby Berkshire's March $3400 calls that recently cost about $182, and selling March $3300 puts for about $155.
If the stock is added to the index, the upside calls should increase in value, while the puts, which were sold to lower the cost of the overall position to under $30, would decrease in value.
Though Standard & Poor's is expected to make changes to its index by year's end, it is impossible to be sure about the timing. To avoid being wrong on the expiration, but right on the strike prices, we chose March options, which provides plenty of time for the trade thesis to work.
The addition of any stock into any index is often a mysterious process. Committees oversee the index, and meet from time to time to evaluate if the index is still true to its objective and technical specifications. Mergers are also a reason to meet. David Blitzer, head of the index committee, was not immediately available for comment.
Jefferies has told clients that Baby Berkshire meets all but the "liquidity" requirement that a stock trade a minimum of 250,000 shares in the previous six months. Of course, a stock split would likely increase trading volume well beyond the average daily volume of 163,000 shares during the past three months.
Even if Berkshire is not added to the index, the options offer a cost-effective way to control, and potentially buy, a stock that is otherwise expensive for most investors.
Comments: steven.sears@barrons.com
http://twitter.com/smsearsBarrons
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