Note that this spread makes more money ever dollar the stock falls below it's present level of $127. It provides increasing protection against loss all the way down to $115 (which would be a drop in the stock price that has happened only 5 times including 9/11 in the last 100 months). If the stock were to go up, this spread would lose money, but that loss would be covered by the higher-strike call calendar spreads that are in place (out basic 10K Strategy).
On July 10, 2008, we set up a new portfolio where the above spread was combined with calendar call spreads at strike prices which were near and above the current stock price. Here is what the risk profile graph looked like with all those positions in place:
We call this new portfolio the Mighty Stalagmite. We believe it is a portfolio that will essentially never lose money, no matter what the market does. In the above graph, you can see that a profit approximating 10% will result (the portfolio value is $10,000) if SPY were to land anywhere between $115 and $133 in five weeks. On July 10, SPY was about $125 so it could fall by $10 or go up by $9 and we would still make that amount.
Part of our strategy is to hold some cash in reserve so that if the stock moves by $7 in either direction, a new modified butterfly spread can be bought that will expand the break-even range so that a loss is averted. When this second spread has to be placed, it is doubtful that the portfolio would gain money in that month, but it should at least break even.
Back-Testing the Mighty Stalagmite: I checked out how these positions might sugar off based on how much that SPY fluctuated each expiration month for the past 100 months (8 1/3 years). It was not a simple task because it involved more than merely checking the fluctuation for a month and seeing what the gain or loss would be on the risk profile graph. Instead, I had to calculate the maximum fluctuation for the month (both up and down) to see if it moved more than $7 so that a mid-month adjustment trade would be triggered.
The results were interesting. Two-thirds of the time, no adjusting trade would be required, and a portfolio gain would be achieved. One third of the time, an adjusting trade would be required, and this happened about equally between upward and downward moves (I had expected there would be more big moves on the downside). Presumably, we would not make a gain in those months but a loss would be avoided.
For one period of time during the back-test (ending with the December 2008 expiration), the proposed configuration of the Mighty Stalagmite would have made a gain in 60 consecutive months.
In one month, the stock deviated from its starting price by a $7 move in both directions, and two adjustments would have been required (the second one would have involved taking off one of the calendars to come up with the cash to do it), and a small loss would probably have been experienced for that month. But that was only one month out of 100.
The greatest change in a single month was $16.70 (in 9/11). On the day that trading was resumed, the stock moved up $4, and two months later it was higher than it was before the tragic event. Only 2 times out of 100 did the stock fall by over $12 in a single month. In each of these circumstances, a butterfly spread that extended the no-loss range by $5 would have covered the unusually large fluctuation.
Next week will expand our discussion to ask if it is a realistic possibility that we have come up with an options portfolio that doesn't lose money no matter what the market does (and may make as much as 10% in a single month if the market only changes moderately up or down).
I hope you are interested enough it this possibility that you would consider coming on board as a Terry's Tips Insider and watching the Mighty Stalagmite unfold in real time (it is one of our 15 actual portfolios).
You can sign up at http://www.terrystips.com/order.php, It could be the best investment you ever made.
Terry
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