Option Investor

Tough Week for Longs

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While the week was tough for long energy positions we did get some new entries and moved out of danger on our short calls. Oil prices appear to be settling around $60 and right where we expected support to appear. We did lose ground on our longs but it was not unexpected. If you remember we sold those short calls back on Feb-21st in expectation of another profit taking dip before the summer ramp begins. So far everything has gone more or less according to plan. I know it is painful for those positions where we did not have a cost reduction scenario in place but nobody ever said the only direction was up.

Cost reduction strategies in play this week saw some of the exit targets hit for nice profits. Six positions benefited from the strategy. We either closed the short calls and/or the long puts on all six. Many more are very close to an exit. Once we get a new bounce we will institute a new cycle.

Cost reduction strategies
closed for a profit:

SU +$3.60
HP +$2.75
GI +$3.75
KMG +$2.20
NOV +$2.90
UPL +$6.30 !!!

We saw tensions cool in the Iran nuclear debate despite warnings and counter warnings from several of the major players. It is possible the U.N. Security Council will take up the Iran matter as soon as next week and tensions should begin to rise again. The U.N. will probably spend a week or so debating the issue then produce a finding that Iran is in default of past agreements. They will warn Iran that they must comply and give Iran some time to think it over. Iran will probably refuse and the council will then begin discussing sanctions. Iran will be warned that they must comply or action will be taken. Iran will probably refuse again stalling for time. The Security Council will propose some sanctions and Iran will again have some time to comply before the U.N. acts. When the time arrives to put the sanctions in force China and Russia will likely threaten a veto and more time will pass while the potential sanctions are debated. The entire process can take as much as two months.

Iran has warned that they will take action against various nations if the U.N. starts squeezing them. While the action remains unclear they said they would produce "harm and pain" and that "nations of the world remain vulnerable to their attack." Iran is a significant threat but they know they can't succeed in anything but harassment attacks and any such attack would bring swift retribution from the major players. You know the U.S. would love a first strike of some kind by Iran to justify escalating the problem into obliteration of their nuclear sites and the end of their nuclear ambitions for quite some time.

This Iran dispute is simply eye candy for energy traders. Until something really happens they may want to remain cautiously long and very few would be aggressive enough to short oil. That means it is still a supporting factor for at least the next two months.

OPEC met last week and agreed to leave production at the same level it has been for months at 28 mbpd. Iraq, not considered part of the quota/production scenario at present is another 1.5 mbpd. Iraq production has been so volatile that it is not counted as reliable production for OPEC. In reality the production quotas are a sham since three countries can't meet their quota and several others are pumping flat out. Essentially OPEC is pumping every barrel they can with the exception of Saudi Arabia. Saudi has about 500,000 bpd of excess sour capacity. Nigeria is still fighting the rebels and the rebels have pledged to knock out another 500,000 bbls of daily production putting a 1-mbpd crimp in the global supply when it occurs. Because of this OPEC has agreed to leave production alone as long as oil remains over $58-$60.

For our purposes those issues remain a cloud over the market despite the decline to $60. Should we decline much under $60 you can expect OPEC to start talking up the price again and threatening production cuts. That OPEC threat is our real support partner.

As we approach mid March we are right at the start of the normal ramp into the summer driving season. We are already seeing heavier than expected demands for gasoline and diesel due to the warmer than normal weather patterns. Gasoline prices have stabilized in the $2.25-$2.50 range and consumers have become used to seeing those prices at the pump. This has set the stage for normal demand to return with sticker shock a thing of the past.

Keene pointed out on Thursday night that the chart for oil looks very much like a head and shoulders with $59 the rough neckline. While I agree this is a potential we are heading into a strong demand period. I personally believe seasonal demand factors will trump the current chart pattern. This does not mean we are not at risk for a continued dip to $58 or even lower but the global demand picture is not confirming a drop in prices. Interest rates are rising around the globe and that is a direct result of global economic growth. Economic growth consumes oil at a faster pace and upsets normal demand patterns.

Nobody has a failsafe view of the future and can predict oil prices at any specific point. The views I am expressing are simply one scenario based on global demand patterns and geopolitical events. Keene's H&S is a purely technical view. Both views are presented for your analysis.

I know we have a lot of new readers this month and I want you to know what to expect. My goals in the LEAPS newsletter is to establish positions with a view for long term investment. We will manage those positions to reduce cost and risk. Ideally our cost in the eventual positions will be less than $5 with substantial upside possible as oil prices ramp into the summer and fall. We will deal with whatever oil price the market gives us and plan our trades accordingly. I am not planning on jumping in and out of trades as the change in geopolitical events produces volatility in oil prices. We will deal with it by managing the positions rather than exiting and reentering.

If oil prices do dive below $58 our long positions will probably be in negative territory for several weeks but we will continue to hold them. It is a proven fact in investing that strong reversals of down trends tend to produce strong gains over a very short period of time. The only ones who capture those gains are those already in long positions. Trying to time the market or pick a bottom typically produces sub standard results. We will continue to enter positions when nobody else wants them because the long-term outlook has not changed.

The watch list was decimated this week after the majority of our targets were hit on Wednesday. Only two targets remain, Tenaris and Titanium Metals. I will not be adding any new candidates since we are now carrying more than 20 positions.

Stop losses, where applicable, will be left VERY loose due to the potential for oil volatility. If the stops are too wide for your risk profile please adjust them accordingly.

Natural Gas Chart - Daily

Crude Oil futures Chart - Daily


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