Option Investor

Please Stop!

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Stop the selling please! This was a very painful week. After all the analysis I did last week on historical expiration trends the law of averages produced a textbook reversal for only the third time in a year. Fortunately I had explained in vivid detail last week how we were due for a sell off and why I was raising the stops on every position to take us out if disaster struck. Dang, the master of disaster himself must have been reading my comments.

To make a long story short we were stopped out of all but ONE position. September crude fell -7% in 3.5 days and many oil stocks with huge profits dropped better than -10%. It was a textbook correction probably brought on by a combination of events.

Oil had just hit a new record high at $67 with Gasoline over $2 and Natural Gas over $10. Records were being broken daily. As we approached futures and options expiration we also were approaching the end of the driving season just three weeks away. We went from 12 refinery outages in the past week to only two in the current week. Oil was flowing and the IEA lowered their demand estimates based on higher oil prices reducing demand. In retrospect it was the perfect storm for the bulls. Hedge funds facing a contract roll over flushed their positions instead of rolling them forward. The story should end there but it doesn't. I will pick up this thought again in a minute.

We had 15 positions stopped out. 10 were profitable and 5 were not. Of the five losers the biggest loss was -1.45 on Chevron and that was related more to the Unocal drag over the last six months than a busted play. It was the only position that lost more than $1. The total loss was $4.35 for an average loss of 87 cents. Three of the losers were less than two weeks old.

The 10 profitable positions posted at combined profit of $54.03 or $5.40 average per position. The largest were APC, +11.50 and VLO +10.10. Many positions and especially Valero declined substantially before they were stopped. Had we exited last Sunday as discussed the profits would have been approximately $2.00 higher per position. Unfortunately trading is inherently risk filled. Hopefully after the extensive rationalization I offered last week those that were more cautious were able to justify an earlier exit than the official portfolio exits. I have no complaints about the profits we derived over the last nine months but I always have seller's remorse about the profits that got away for whatever the reason.

Exit Table for week of 8/19/05

Now, back to the future. The September crude contract is history after Monday and the October contract closed on Friday at $65.90, only +30 cents above September. No real bias is evident for Monday. Now, as we have seen over the last 12 months there has been a very strong reversal of direction when each contract expired and the new contract began trading. Only two months out of the past 10 has the prior trend continued.

Last week those averages bit us but until proven wrong I believe we need to continue playing the odds. That would be for a rebound in oil beginning on Monday. However, we have some new considerations this month. Those considerations are for the switch in demand from gasoline to heating oil and an increase in jet fuel and diesel. Normally many refineries experience some downtime as they make the conversions. They also use the switch over to perform needed maintenance tasks. Sometimes these do not go as planned.

Here is what I am pondering this week. Personally I am long oil from Thursday night's closing rebound with about a 50/50 position. Half invested, half in cash. The Friday rebound was kind to me so I can afford to wait and see what Monday brings before taking the next step.

If you look at a bunch of oil charts this weekend you will find quite a few that rebounded to a dead stop early in the morning and never budged a dime for the rest of the day. It looked like short covering but no follow on buying. ECA, MRO, SUN, etc. Was that just a lack of buyers on a late summer Friday or a clue that there are still sellers waiting overhead? I am hoping it is the former and everyone was just waiting for options/futures to expire before entering new positions. However, APC, TLM, COP and several others were showing an uptrend into the close.

While I would like to just give you a list to reenter on Monday I am leery of a blanket "go long" call this weekend. I am going to add a lot of the prior positions back to the watch list with triggers on both breakouts and breakdowns. Some I am only going to use breakdowns because of concerns I have about the calendar. I also added several coal stocks to the watch list. There is no "season" for coal since 50% of the electricity in America comes form coal.

We did initiate two new positions on last weeks dip. Both HP and TLM were triggered bringing the number of active positions to three!! That is a far cry from the 16 we had last week.

The chart below is a reprint from last week showing the various futures expirations and the movement after expiration. The many reversals are my rationale for potential longs next week. Let's let the market pick our entries and for once we would be grateful for one more major drop.

September Crude Chart - Daily with all expirations


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