The Mighty Mesa

A Tested Options Strategy Designed to Never* Lose Money (and Just Might Make 36%)


PART I: THE STOCK MARKET WORLD

WHITHER GOETH THE MARKET?
The large number of stocks they cover means that random errors in individual stocks become insignificant. Analyst errors on individual stocks tend to cancel each other out.

BUYING STOCKS AND MUTUAL FUNDS
An analyst down-grades the stock.

The company fails to meet expected quarterly earnings.

The company meets “whisper” earnings number but falls short of sales expectations.

The company meets the “whisper” numbers but issues a gloomy outlook for the future.

Cooking the books

Back-dating management stock options grants

The company loses a big contract to a competitor.

The market as a whole falls, taking down most stocks with it.

If you still insist on buying individual stocks regardless of the miserable odds of being successful, there is an options strategy that works better than the outright purchase of the stock. If the stock goes up, the strategy will result in far greater percentage gains than if you had bought the stock instead. And if the stock stays flat, you will make a small profit – something you wouldn’t make if you just owned the stock.

On the other hand, in terms of mutual funds, year after year millions of investors pay mutual fund managers billions of dollars to underperform the market. “Most of my investments are in equity stock funds.” Even a famous stock broker agrees that “Most of the mutual fund investments I have are approximately 95% index funds.”

Pity Your Broker. Your broker will most certainly never tell you about trading options.

Commission rates of full-service brokers are too high for you to make money trading options especially the kind of spreads the author recommends

Everyone ‘knows’ that options are extremely risky. Most options expire worthless thus; option traders must be losing their shirts if he recommends options to you because, you may sue him if you lose your money.

The Analysts. If brokers really don’t know which are the best stocks to buy, what about the analysts?


PART II: THE WORLD OF OPTIONS

STOCK INVESTING VS. OPTIONS INVESTING
The biggest differences between the world of stocks (or mutual funds) and the world of options can be explained in mathematical terms. Stocks change arithmetically and options change geometrically.

Comparing the arithmetic changes in the stock portfolio with the expected geometric changes in a Mighty Mesa portfolio, these things are true:

If the underlying stock stays flat or goes up by 1%, 2%, 3%, or 4% during one expiration month, the portfolio value will increase by an average 4%-10% after commissions.

If the underlying stock stays flat or goes down by 1%, 2%, 3%, or 4% during one expiration month, the portfolio value will increase by an average 4%-10% after commissions.

If the underlying stock goes up or down by 5% during one expiration month, the portfolio value will most likely break even (on average).

If the underlying stock goes up or down by 6% or more during one expiration month, unless adjustments are made, the options portfolio will lose money. That loss could be doubled or more of the percentage loss in the underlying stock.

If the underlying stock falls by 15% in one expiration month, unless adjustments are made, the options portfolio could lose 40%.

PUTS AND CALLS 101
Basic Call Option Definition. Buying a call option gives you the right (but not the obligation) to purchase 100 shares of a company’s stock at a certain price (called the strike price) from the date you buy the call until the third Friday of a specific month (called the expiration date).

People buy calls because they hope the stock will go up and they will make a profit, either by selling the calls at a higher price, or by exercising their option.

Basic Put Option Definition. Buying a put option gives you the right (but not the obligation to sell 100 shares of a company’s stock at a certain price (called the strike price) from the date of purchase until the third Friday of a specific month (called the expiration date).

LEAPS are long term stock options.

CALENDAR SPREADS AND BUTTERFLY SPREADS
Calendar spreads are the basic foundation of the Mighty Mesa Strategy. They involve buying an option that has several months of remaining life and simultaneously selling another option in the current month with both the long and short option having the same strike price. Since the longer-term option will always be more valuable than the short-term one, buying the spread will involve the outlay of some money (when you place the order, it is called a debit).

A butterfly spread is an interesting options tactic if you think you know where a stock will end up at expiration.


PART III: PUTTING THE MIGHTY MESA STRATEGY TO WORK

SETTING UP A MIGHTY MESA:
Calculate the desired break-even range of possible stock prices (for SPY, it is recommended about 8% in either direction from the stock price).

Place a small number of calendar spreads (2-5 months of remaining life for the long side, one month of remaining life for the short side) at strikes just below and above of the starting stock price. Use puts for the calendar spreads below the stock price and calls for calendar spreads at strikes above the stock price unless, there is a price advantage for those closest to the stock price.

In other words, if the call calendar spreads are less expensive, they can be used for strikes slightly below the stock price.

Place a larger number of calendar spreads at a strike approximately half-way between the stock price and the lowest strike in the break-even range that you have previously selected.

The number or spreads should be at least double or triple the average number of calendar spreads that are placed at the various higher strikes.

For the most conservative portfolio, set aside 10% of portfolio value for possible adjustments.

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