n Berkshire Hathaway's (BRK.A) Annual Report, Buffett announced that Berkshire has taken in $7.7 billion in premiums on 94 derivatives contracts it has entered into.Buffett said he has taken in $3.2 billion in premiums on 54 derivative contracts that require the firm to pay up if certain bonds in various high-yield indexes default. The options expire between 2009 and 2013, and could expose Berkshire to losses as large as $4.7 billion. The odds of that are "extremely unlikely to occur" according to Buffett, who said that as of Dec. 31, Berkshire had paid out just $472 million on those contracts.The remaining options come from the sale of put options, which give the buyer the right to sell a contract to Berkshire at a certain date. Buffett says the company has sold 15- or 20-year put options on the S&P 500 and three foreign indexes. The puts are exercisable only at their expiration, which is between 2019 and 2027. The options were struck at the market price on the day they were written.Essentially, Buffett is betting that stock prices will rise over the next 15 to 20 years. This means that any rise in the S&P to levels above the level on the day the contract was written renders to options worthless to the buyer. On the put option sales Buffett has taken in $4.5 billion in premiums.The selling of put options is a great way to add to your returns and decrease your cost basis on the purchase of a stock. If done correctly, the strategy is very low risk. You sell out of the money put options on companies that are trading at prices you would buy the stock at today. In this scenario if the stock rises, you keep the money and walk away, if the stock drops in price (below where you sold the put at), you are then forced to buy the stock but because you sold an out of the money put, you are buying it at a lower price than you would have initially.This only works in stock that you would want to own and hold. The worst thing would be to own a stock in a company that you have no interest in.
