A DIAmond Success Story!

One month ago, we created a $10,000 portfolio using the Dow Jones Industrial Average tracking stock (DIA) as the underlying. We established calendar spreads in calls at the 115, 116, 118, 120, and 122 strikes, and what we call an exotic put butterfly spread at the 114-110-106 strikes.

Here is what the risk profile graph looked like when we started out the month:




You can see that this portfolio would be expected to make a profit if DIA ended up anywhere between $110 and $123 in five weeks. In the great majority of months, DIA could be expected to remain in a range of that size for a 5-week expiration month. When we set up these positions, DIA was trading about $116.50, right about in the middle of the break-even range.

Our goal each month is to create a graph that looks more like a mesa than a mountain. We didn't totally achieve that goal with the above graph. As the month progressed, we took off some of the 120 calendar spreads and replaced them with more calendar spreads at the 115 strike. Those trades made the entire curve flatter. The expected gains for the month averaged about 15% across the same break-even range as the above graph.

Four of the five weeks have now expired. During that period, DIA traded as low as $110.50 but we were not tempted to make adjustments that would have expanded the downside break-even point to a lower number, and our patience was rewarded when the stock headed back to close last Friday at $114.79.

The portfolio is now worth $11,403 for a gain of 14% after commissions for the last four weeks. We have a policy of withdrawing cash from a portfolio whenever 6% is earned in a single expiration month. This month, we have had to withdraw that amount twice ($1200 will be withdrawn on Monday).

In order to generate sufficient cash to make that withdrawal, we rolled over the 120 calls (buying back the Sep-08 120 calls and selling Oct-08 120 calls) and closed out (sold) the 122 calendar spreads. With a week to go until expiration, we are still looking forward to additional gains over a fairly broad range of possible stock prices:



You can see that an additional 10% gain might come our way next week if DIA closes somewhere between $110 and $118. That would make a 24% gain for the 5-week expiration month.

How many investments do you know of which can make 24% in 5 weeks when the underlying ETF remains essentially flat (actually, it has lost a couple of dollars in value over the last month)?

For the 7 years of Terry's Tips' existence, we have called our strategy of multiple calendar spreads the 10K Strategy. Now we have made a change. Since we have added butterfly spreads and changed the basic objective of the strategy from making 50% - 100% annual gains to one of never losing money, it seems that we should no longer call it the 10K Strategy.

The new name for our basic strategy is the Mighty Mesa. The name derives from the desired shape of the risk profile graph when we start out each expiration month. For a while we were planning to call it the Mighty Stalagmite (a similar but smaller rock formation, but one which hangs out in caves, making it most un-photogenic, and I needed a nice photograph for the cover of the new book I am writing). So we are going with the mesa. You don't mess with a mesa.