Option Investor

Are We Having Fun Yet?

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If a $20 run in Valero does not make you jump for joy then have somebody check you for a pulse. It was an outstanding week in the energy sector and for the LEAPS portfolio. Every stock was up substantially and they gave back very little on Friday.

Oil settled at $67.57 and right on light support after promises from Bush and the IEA promised a total of 90 million bbls of crude and refined products. You would have thought it was manna from heaven from the positive comments in the press. In reality it is just a finger in the dike ahead of the Q4 demand cycle.

I believe that once we get the inventory numbers on Wednesday we could see another new rally begin. However, the summer driving season is over on Tuesday and gasoline demand will slow. Demand for diesel, jet fuel and heating oil will begin to increase as the cyclical Q4 demand begins to ramp up.

The refining capacity is still short more than a million bbls per day with four refineries likely out for at least a month. This should put us well behind the demand curve.

In short, the recommendation is to buy the dip and hold on until December. Originally I had expected to exit our earlier positions during September once the driving season had ended. We got knocked out a little early and bought the dip as oversold in hopes of catching the next wave. Surf's up! The wave was much stronger than expected due to the Katrina damage and with the refinery problem and the rig problems in the Gulf there is every indication that it will continue for several months. The game plan now would be to look for an exit in the December time frame and then buy the dip in March. That of course assumes the demand calendar plays out as expected.

Now the question most asked this week. I was ***** and missed the entries when should I enter now? I believe the Friday selling was just profit taking before an early Nymex close and ahead of a three-day weekend. The October crude contract returned to its 100/130 ema on the 30-min chart and what appears to be an initial buying opportunity before stronger support at $66. As I type this on Friday night it looks like a buyable dip. I can't imagine any scenario where oil demand/production works out favorably over the next two months so I remain bullish.

We are just entering the two worst months of the year for hurricanes, Sept/Oct and the weather service is still expecting 8-10 more hurricanes. Given the increased activity so fat this year that may be a very good guess. Also, they are predicting a colder than normal winter in the northeast. The same weather patterns that produce the strong hurricane season also produces a below average winter. Better stock up on heating oil now because another Gulf storm could put the energy sector down for the year.

Lehman is sponsoring an Energy Conference next week with many of our companies presenting. It could give another pop to the stocks as well as the Wednesday inventories.

All of our watch list plays were triggered so we have a full portfolio once again.

Crude Oil Chart - Daily


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