Option Investor

Nearly Perfect Entries

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When I added those puts over the last two weeks I thought I might have to wait until next week before seeing any real decline. I positioned us earlier than I was planning because of the spike in crude to the same highs we saw last July but with crude inventory levels now at ten-year highs. Gasoline was falling as expected and the stage was set for a crude decline in August. I am sure glad we took the entries last week.

The plan did not work out exactly as expected although I was pretty confident when crude fell back to $73 on Tuesday that the plan was unfolding just a little ahead of schedule. When the Globex trading platform went offline for 80 minutes on Wednesday all hell broke loose. Unable to see their positions when the platform went down thousands of traders panicked and called in their buy orders to avoid being trapped in a short position and unable to execute orders. 80% of all crude contracts trade electronically. The Nymex reverted back to a manual ticket system and the pit was flooded with buy to cover orders. This started a chain reaction rebound. When Globex came back online those traders sitting in the dark suddenly found themselves racing to cover shorts squeezed by the outage. The rebound short squeeze continued to produce a +$2 gain before the close and news powered it higher overnight. $77.24 was the Thursday high before the market implosion knocked $2 back off the price. Friday saw another move higher on no news and shorts again raced to cover. The market reporters kept talking about volatility returning to the equity markets but the real volatility was in crude.

Nobody really knows why crude prices are moving higher. There is no rational explanation and nothing on the global news front to power the move. The IEA continues to pound its new shortage drum but nobody is listening just like nobody listened when they said there was plenty of oil until 2030. OPEC has no incentive to raise production because global inventory levels are still rising. The momentum players seem hell bent to push prices to $80 and after Friday's rebound they might just make it.

My view was always for the highs to be put in place at the end of July and the beginning of August. Then, assuming there are no hurricanes in the Gulf of Mexico we would see a normal decline into September on lower gasoline demand and falling gasoline prices. So far everything is following the script almost exactly and as of Friday night there are no hurricanes on the horizon. I hate to think where prices would go if a storm appears west of Cuba over the next week or two.

Crude inventories in the U.S. are now 13.5% over the 5-year average and that should be very bearish on prices. Tanker tracker Petrologistics said OPEC output was set to rise +300,000 bpd in August as cheating on quotas grows due to the high prices. Even Iran said they would increase production if needed. OPEC said last week $65 was a reasonable price for crude and that was seen as a potential level that OPEC would support by raising output. If prices are too high it drives rapid exploration. Too low and exploration slows. OPEC seems to be thinking $65 is the Goldilocks price where they are still in control, drilling is stable but not hectic, demand does not slow and OPEC revenues are stabilized. This should have a calming effect on prices but nothing has slowed yet.

Gasoline inventories are declining slower than normal and refinery utilization is finally rising steadily. Crack spreads are back to 21 cents per gallon and well off the $1 per gallon we saw earlier this year. That is still $8 per barrel but well off the $40 they were getting when the spread was a buck. Refinery utilization rose to 91.7% compared 92.5% last year. There is nothing in the data to support higher crude prices.

For the last several weeks I have been raising stops on our existing positions in anticipation of the late July, early August decline. I wanted us to stop out for a profit at the highest possible level. Historically stock prices tend to weaken before crude prices in anticipation of the normal decline in crude. This year was no exception.

However, we got an added assist from the broader market dump and some high profile earnings challenges in several energy stocks. We were stopped out of all but two energy longs and we closed SLB and GSF prior to hitting the stops. All in all it was a very successful exit with most positions very profitable.

If you have been a reader of the LEAPS newsletter for long you know we targeted the drop in prices last winter and then added to positions with the expectations of an exit now. So far so good! The next challenge is to re-enter our energy positions on the fall dip and spring dips and ride them back into the July highs. It may sound like a boring plan but it works very well.

Starting this issue I am going to begin adding some new watch list entries with what may seem like unreasonable targets. Once oil declines back to $60 those targets will be a lot closer and I will adjust them as needed to give us our next set of entries.

I am also going to start adding a couple more non-energy positions to keep it interesting while we wait for crude to dip.

The next few weeks may be boring while we wait for entries but bear with me. Enjoy the puts on CVX, TSO and the XLE while we wait. Beazer is not doing badly either! The object of the LEAPS newsletter is not to trade just to be trading but to trade when it is profitable. There is a difference. Last year I did press some entries and ended up paying the price trying to recoup option prices with secondary insurance puts and covered calls. I would rather just make better entries and avoid the hassle of trying to time the market on a monthly basis. I am always open to suggestions from readers so fire away if you have an idea.

Jim Brown

September Crude Futures Chart - Weekly

August Gas Futures Chart - Daily

August Gasoline Chart - RBOB Daily


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