Option Investor
Commentary

That Was Really Painful

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The profit taking finally arrived but it was much stronger than I expected. Oil prices fell from last Friday's $75.25 to hover just over $70.50 on Thursday. By itself the drop in oil would not have been that damaging given the geopolitical climate. When coupled with some earnings that missed the boat, the surprise rate hike in China and the Presidents removal of the ethanol requirement it was a massacre. Several stocks dropped close to $10 and despite oil's resurgence on Friday there have been no general rebound in energy stocks. I believe this is temporary but what I believe is immaterial to the markets.

Much of the declines was due to the dumping of stocks after they posted earnings. Personally I don't ever like to hold a trade over earnings and it has long been an Option Investor policy not to do it. However, the LEAPS Trader tries not to be a trading vehicle and more of a long term investing guide. For investors with an outlook of a year or more we have to withstand these temporary setbacks. Fortunately we did sell some more covered calls last week to reduce our LEAP premiums.

I got several emails from readers unpleasantly surprised by the sharp drops in stocks with great earnings. This is a fact of life in momentum investing. Traders buy the ramp into earnings with high expectations then dump those positions once earnings are released to move on to another play. Traders always seem to expect that strong earnings should produce a massive spike. Unfortunately that only happens when expectations are lower. The lower the better if you are betting on a spike. Shorts load up and are squeezed out on favorable news. On stocks with great expectations the hopes of traders are fanned into a fever pitch. Those hopes are almost always dashed simply because companies cannot meet the unreasonable expectations. Traders bail instantly in hopes of finding a new candidate. With oil at $75 it would be hard to meet any expectations despite that $75 level being attained after the quarter ended. There is a disconnect between reality and expectations given the trends in energy prices.

There were some real standouts like National Oilwell Varco who more than doubled earnings on nearly a double increase in revenue. Unfortunately NOV spiked to $72.50 on the news only to drop to $64.80 the next day on the post earnings depression and the China news. This scenario was repeated in almost every position we owned.

Oil closed at $71.85 but I believe we will see the highs broken again before summer. The rhetoric from Iran is too hostile and inflammatory to be resolved peacefully. It is simply a matter of time before the matter escalates to a serious problem for the energy sector. We are also only four weeks from the start of the hurricane season and that should provide some additional support to prices. Support for crude is currently $70 with the next level in the $67-68 range.

Pay attention to the commentary for any positions you currently own as there was a lot of activity last week. I will be making some changes to prevent further shrinkage in case of a breakdown to the next support level.

I definitely exited the IYE puts too quickly at $97.50. The China rate drop took it down to $94 before the rebound began. We made a nice profit but it would have doubled had we known the news was going to be in our favor.

I also put the profit stops on the covered calls too close to the current price. Several saw large dips of $4-$6 almost immediately and that took us out of the call before the premiums had a chance to bleed. Sometimes you just need some luck to go along with best laid plans.

I had planned on adding BNI as a replacement for CNI but as the week progressed the bottom fell out of the rails. At least all but the CSX position we are already in. Instead I added TS to the watch list as a possible replacement for CNI/KMG. I also swapped Goldcorp for Newmont Mining as our potential gold play.


Oil Service Index - Daily

June Crude Oil futures Chart - Daily

December Crude Oil Futures Chart - Daily

June Natural Gas Futures Chart - Daily

December Natural Gas Futures Chart - Daily

 

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