Thank Warren Buffett For This Income Trade

Reading academic research isn’t the most exciting part of my day, but there are often some great ideas in these papers. Although, what’s funny to me is that these great ideas aren’t always the ones the researchers think are important.

The researchers looked at the returns of hedge funds and correlated the returns to the funds’ use of the Security and Exchange Commission (SEC) database of corporate filings. They found that funds that are heavy users of the database “subsequently exhibit 1.5% higher annualized abnormal returns than non-users.”



CNBC summarized the story by noting that “fund managers that do the most research will post the best returns.” But, the real story isn’t the fact that funds use information. To me, the real story is what information funds use. Data shows they use insider information.

Company insiders are required to report any transactions they make in a company’s stock. This requirement includes company officers, members of the Board of Directors and outside investors who own more than 5% of the company.

The paper found, for example, that Renaissance Technologies downloaded more than 4 million SEC filings between Jan. 1, 2003 and March 31, 2017. More than 85% of those downloads were reports of insider activity.

Renaissance is the most successful hedge fund of all time. It doesn’t report its performance publicly, but one source indicates that from 1994 through mid-2014, the fund averaged a 71.8% annual return.

Based on the fund’s performance, Renaissance’s interest in insider activity reinforces my belief that it’s an important metric to follow. And for good reason: Big-name investors often conduct high-level research before making an investment. (With millions of dollars on the line, who wouldn’t?)

And even though all of their private research is, well, private, the stocks that they’re buying and selling aren’t.

These notifications are made in reports called SEC Form 13F. Investors managing more than $100 million are required to report their holdings at least once every three months on these forms, providing some insight into the normally secretive world of big-time investors.

I find the 13F to be extremely valuable. Many of these reports are filed by large investors who tend to buy and sell positions over time. We can also research what style each investor implements. This allows us to ignore the filings from short-term traders and focus on the best long-term, value investors like Warren Buffett.

What Buffett Is Buying Now…

And speaking of the Oracle of Omaha, recent reports on insider activity included news that Buffett recently increased his stake in high-tech farming giant, Monsanto (NYSE: MON).

This appears to be a merger arbitrage trade, one of Buffett’s favorite strategies. These trades involve stocks of companies that have announced mergers or acquisitions. The terms are set and the deal will close, but the date of closing is unknown. The uncertainty associated with when the deal will close can lead to trading opportunities.

As Buffett explained in his 1988 letter to Berkshire Hathaway shareholders:

“In past reports we have told you that our insurance subsidiaries sometimes engage in arbitrage as an alternative to holding short-term cash equivalents. We prefer, of course, to make major long-term commitments, but we often have more cash than good ideas.

At such times, arbitrage sometimes promises much greater returns than Treasury Bills and, equally important, cools any temptation we may have to relax our standards for long-term investments.”

When evaluating these trading opportunities, Buffett says investors must be able to answer four questions. Again, from the 1988 letter:

“To evaluate arbitrage situations, you must answer four questions:

(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire — a competing takeover bid, for example? and
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?”

My most recent Income Trader recommendation is a merger arbitrage trade in Monsanto. So, let’s walk through Buffett’s questions.



(1) How likely is it that the promised event will indeed occur?

This deal was proposed in May 2016. At that time, Bayer agreed to acquire Monsanto for $128 per share in an all-cash transaction valued at $62.5 billion. The chart below shows the stock jumped to about $105 on the news.

The stock price reflected the uncertainty associated with the news. Regulators around the world would need to agree to the combination because the deal would create a company that controlled more than a quarter of the world’s seed and pesticides market.

Regulators have been demanding divestitures of various business divisions and other terms, but the deal is nearing final approval. In March, European regulators approved the deal. Indian regulators approved the deal this week, and Russian authorities also acted recently.

The only significant hurdle was approval from the U.S. Justice Department, which gave the go-ahead on Tuesday. After completing the sale of some assets, the deal is expected to close within months.

(2) How long will your money be tied up?

This can be a problem for traditional arbitrage trades. But thanks to the strategy my readers and use in Income Trader, our money will be tied up for just a few weeks.

(3) What chance is there that something still better will transpire — a competing takeover bid, for example?

At this point, there is virtually no chance a competing bid will come in. That means the deal should be on track and there should not be any surprises.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

Financing is in place and, after two years, the regulatory challenges have been overcome. Both companies are committed to closing the deal, and there is virtually no downside risk at this point.

The answers to Buffett’s questions indicate we have a high-probability income trading opportunity.

How I’m Trading This Stock

If you’re interested in following Buffett’s lead, you could have bought shares of MON and caught some of upside from recent prices.

But I found a better trade… One that allowed my subscribers and I to collect 2% in income in just 24 days. That’s a respectable 33% annualized. And all without buying a single share of the stock.

How are we doing this at Income Trader? By using a high-income, short-term put option on MON.

Now, I understand not everyone is comfortable selling options, but you shouldn’t let that fear or nervousness keep you from taking advantage of this tool. Because that’s what options are — a tool for traders. They can be as risky or conservative as you want them to be. It all depends on the strategy you’re using.

Like I mentioned above, my strategy is one of the safest around. In fact, I’m making a guarantee to new subscribers to show how low-risk options can be:

If you follow along with my trades and don’t make money at least 90% of the time… I’ll work for you for free. That’s how confident I am.

I recently released a special report that will tell you everything you need to know, including how my readers are making about $568 a week from selling options. There’s even a list of three questions to ask yourself to help determine if you’re ready to trade options. Simply follow this link to check it out.

— The Option Specialist

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