Option Investor

Weekly Newsletter, Saturday, 04/16/2005

Printer friendly version

Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing
  4. New Plays
  5. Existing Plays

Leaps Trader Commentary

Excited Yet?

Last week the headline was "Excitement Just Ahead" and we definitely saw some volatility in the markets. Unfortunately that volatility was all to the downside and any long positions were beaten severely.

The bright side was oil's return to $50 and our patience was rewarded. We have multiple new plays today.

The FDX put we retained from the busted FDX play last week closed at $10.50 on Friday. I doubt anyone held it into the close but it started the week out at $5.30 and completely erased the 95-cent loss on the leap. The recommendation was to hold it if transports were still falling and that turned out to be the best play. Brave traders who held it all week were well rewarded.

I am glad I tightened the stop on Adobe to take us out for a nice profit because the bottom fell out over the last three days. Our stop at $66.50 was hit on Tuesday morning and it closed at $60.65 on Friday. Funds were definitely selling the winners to raise cash.

Symantec also took a header off the high board into an empty pool and I am giving up on that position. Our insurance put is now $3.60 in the money but not quite to a breakeven on the overall trade. I am closing the leap and retaining the put.

Our puts are working nicely with JBLU, CAL, OSTK, TOO and GM all falling with the market. The airlines fell despite the drop in oil, which should tell us something about the future.

Unfortunately we did not get filled on the DJX puts on Tuesday. The trigger point was 10550 and the Dow only made it to 10529. I would like to take credit for having the right plan but it failed because I was too greedy on the entry. Tough to pick those numbers exactly several days in advance. (grin) Hopefully anyone ready to take that trade would have fudged once the Dow rolled over 20 points below our target. Those $6 puts are now $7.50.

I said last Sunday that the week would be a critical week in the market and my target for a turning point was Friday April 15th. Looks like I was a couple days late but then we don't know what next week is going to bring. It could be exciting!

Changes in Portfolio

New Plays
$39.75 Energy SPDR

Dropped Plays
$60.65 Adobe Software ** Profit stop at $66.50 **
SMH $29.93 Semi Holders ** Dropped, thank you IBM **
SYMC $18.89 Symantec ** Close LEAP, retain put **

New Watch List Plays Triggered
VLO $67.61 Valero Energy
PCO $54.34 Premcor Inc

Portfolio Listing & Top Picks

New Plays

Most Recent Plays

XLE - $39.75 Energy SPDR ** No Stop **

The XLE SPDR is composed of 27 energy stocks and represents about 8% of the SPX. This is the 8% that helped push the SPX to the current levels with the rise in oil over the last year. In fact the XLE has far exceeded the SPX in performance over the past year.

The XLE functions like an energy index and should rebound or bottom before oil stocks in general. Once traders start nibbling at the individual stocks in the index we will get our first glimpse of a rebound in the making.

The target was for a dip to $38 but after the weeks activity I decided to jump in early. The XLE has strike prices at every point compared to every $5 for individual stocks. This makes the cost of entry cheaper as well as the cost of insurance.

I chose a leap close to the money because there was no material price difference for the Leaps $2-3 away. Insurance is cheap and I expect this to be a very long term play.

BUY 2007 $40 LEAP Call ORJ-AN currently $5.60

Insurance put:
Buy June $39 Put XLE-RM currently $1.35

Entry $39.75 (4/18)

XLE Components

VLO - $67.61 Valero Energy

Valero is the largest independent refiner in the U.S. and one that has made the switch to the higher profit margins of sour crude. Oil prices are generally quoted using the West Texas Light Sweet price, which closed on Friday just over $50. The sour crude sells for significantly less and will become the dominant variety as oil supplies dwindle. Sour crude has been running about $10 a bbl under sweet crude. Valero is seeing even bigger discounts from less desirable grades from Mexico and Alaska. It costs more to process the sour crude and fewer refineries can handle it. This forces the price of that sour crude lower. Finished gasoline is priced basically on the price of a barrel of sweet crude. This means the same gas Valero produces from cheaper sour crude sells for the same price as the gas produced from sweet crude. This enables Valero to capture a significant profit margin. They had a record year in 2004 due in part to their ability to process the cheaper grade of oil. The company has already said 2005 profits will be higher in 2005 even if margins narrow for others.

Company website: http://www.valero.com/About+Valero/

Valero will report earnings on April 21st and they are expected to be very strong. However, we still want to buy the insurance put just in case disaster strikes.

2007 $75 LEAP Call VHB-AO @ $14.10

Insurance put:
June $60.00 VLO-RL currently $2.05

Entry $68.00 (4/15)

PCO - $54.34 Premcor ** No Stop **

Premcor is a high margin refiner with upside potential from diversification. Premcor processes 800,000 barrels of oil per day with four refineries. They produce gasoline, diesel and jet fuel. The company can process 450,000 bbls per day of high sulphur heavy crude similar to the Valero story.

Premcor is highly diversified with geographic locations, different products and some markets that are not saturated from close proximity of other refiners.

Premcor is seen to have more upside than the more fully valued refiners in that it is seen to be under owned and not fully understood. They will announce earnings on April 28th.

On Friday PCO dropped -3.20 on news that they had a refinery outage of 150,000 bbls due to an equipment failure. This pushed it below support at $56 and gave us our entry.

2007 $60 LEAP Call VJE-AL @ $9.60

Insurance put: June $50.00 PCO-RJ currently $1.95

Entry $56.00 (4/15)


Play Updates

Existing Plays

CVX - $52.25 Chevron Texaco ** No stop **

Chevron fell harder than the rest of the oil group this week but I am still very comfortable with the position. Once the digestion of the Unocal news is over CVX will end up with a fortune in new reserves. Our $55 insurance put is now $3 in the money and we have very little risk.

Chevron announced in early April that it was purchasing Unocal for $18 billion in cash and stock and both CVX and UCL dropped sharply. This was not a surprise for Chevron to make the purchase but the timing caught everyone off guard.

In theory everyone was waiting for oil to drop in Q2 and allow the next round of acquisitions to be made at a more reasonable value. Instead Chevron did a take under on Unocal by offering less than the current share price. It is a good deal if you can pull it off.

Chevron beat out several other firms including China's CNOOC who had been a hot pursuer but had to drop out at the last minute after it could not complete the final terms in time.

Chevron will likely sell off about $3 billion in non-core assets once the deal is consummated. The main asset Chevron wanted was the 1.7 billion barrels of proven reserves and tens of thousands of acres of additional leases still to be explored. Chevrons current average cost of produced crude is $27. After selling the non-core assets they will end up with the Unocal proven reserves at about $9 a bbl plus billions in other assets like gas fields, power plants and joint ventures around the world. This was a very sweet deal for Chevron.

It may take some time for the cloud to lift from the stock price but the next jump in oil prices should do wonders. Chevron dropped back to its 100-day average at $55.50 on the news and this should be very strong support. There is not expected to be any hurdles to getting the deal approved as most of the assets are either out of the country or will be divested as part of the deal.

The Unocal leap was actually triggered when the price hit $59 on the announcement. With UCL trading at $58.74 at Friday's close there would not have been any material movement. Because any Unocal leap will eventually end up being a Chevron leap I am electing to use the previously recommended Chevron leap as the actual position. I am using Friday's close for the entry price.

BUY 2007 $60.00 LEAP Call VCH-AL currently $5.60
BUY 2007 $57.50 LEAP Call VCH-AY currently $6.70
Reference: UCL 2007 $60 LEAP Call VCL-AL @$6.60

Insurance Put:
June $55 Put CVX-RK currently $1.65

Entry $56.67 (04/07)

JBLU - $19.04 Jet Blue ** No Stop **

JBLU faded from its highs early in the week despite the drop in oil prices. Resistance at the 100-day average held and the ugly markets took their toll.

This is a long-term play as airlines will eventually be hit hardest by rising oil prices. It is strictly a play on oil and the change in environment for the airlines. The Q2 demand drop was expected to provide a drop in oil and a rise in airline prices. It happened almost exactly as expected. Now we sit and wait for the reversal.

2007 $20.00 LEAP Put VYO-MD @ 4.60

Insurance Call: June $22.50 JCQ-FX @ .85

Entry $19.50 (4/05)

TOO - $22.79 TOO Inc ** Stop Loss $25.50 **

TOO broke support at $23.50 and it could be difficult for the retailer to climb back over that level given the current concern over consumer spending. The 200-day average at $22 is the only remaining support before $16.

Too, Inc. is a specialty retailer that sells apparel, underwear, sleepwear, swimwear, lifestyle and personal care products for young girls. Recently some negative news has begun to surface from brokers and analysts. It appears TOO maybe having some problems and is losing market share. In order to reclaim that share it is offering what some brokers describe as absurd incentives to attract buyers.

Merrill lynch analyst Mark Friedman said last week that weak sales were a growing concern and we could see an earnings miss for Q1. He lowered same store sales growth estimates to an anemic +3%. He also cautioned that their current sales promotion may be TOO much of a good thing. They call it the TOO Bucks promotion. If you buy $50 of merchandise they will give you TWO $25 coupons to use at a later date. Previously they had offered the same promotion with only one $25 certificate. Friedman feels that giving away $50 in certificates for every $50 sale could be an act of desperation and definitely one that will impact profits. If the promotion catches fire and becomes a strong success then Q2 should suffer greatly as all those certificates come back to haunt them.

The chart clearly shows a loss of momentum and a potential for a sharp drop if an earnings miss occurs. With gas prices putting the squeeze on consumers the retail sector is not a promising place to be long.

TOO does not have LEAPs so I am recommending the November options.

BUY NOV $22.50 PUT TOO-WX currently $2.05

No insurance call.

Entry $24.22 (4/10)

GM - $25.69 General Motors ** No Stop **

GM broke support at $28 and is heading south at a high rate of speed despite the drop in oil prices. I could easily see single digits in the distant future given the various troubles ahead.

My long-term view is very bearish on the automakers due to the potential for $100 dollar oil over the next year or so. If $2.50 gas is bad for business $5.00 gas will be a death knell for gas-guzzlers.

With earnings approaching there is a good possibility GM will reveal some more negative details about its profits and its pension/healthcare problems.

I am using the 2007 leap puts because I think this will be a long term problem for GM and the other car makers as well. We could easily see prices in the teens before this put expires.

2007 $30 PUT VGN-MF Currently $7.20

Insurance Call
May $30 Call GM-EF Currently $1.50

Entry $29.35 (4/04)

CAL - $11.98 Continental Airlines ** Stop $14.50 **

CAL felt the heat despite the falling oil prices and broke support at $12.50 to close at a two week low. No real change here but once oil begins to rise again I believe we will see fewer flyers on higher ticket prices.

The airline industry as we know it is doomed. It is only a matter of time before it becomes too expensive to fly due to dwindling oil reserves and the tens of thousands of current routes will be cut in half and possibly half again. There is no substitute for oil to keep the planes in the air and that means costs will continue to skyrocket. Those airlines with defined benefit pension plans will be stuck with shrinking routes, more layoffs, higher costs and lower profits. In the not too distant future air travel for fun will be a fond memory and heading off to grandma's for the weekend or to Vail for skiing will simply be too expensive to justify.

Business travelers will be the majority of the fares and the high cost of those fares will restrict them to only the absolutely necessary trips.

I am very bearish on the future of the airlines and it is only a matter of time until the rest of the world catches on to the coming reality.

2007 $10.00 LEAP Put OVJ-MB @ $3.10

No insurance call due to the low price on the Leap.
A rise to our stop at $14.50 would generate about a
$1 loss in the leap and that is less than a insurance
call would cost today.

Entry $12.00 (03/31)

OSTK $40.97 Overstock.com ** Stop loss $46.50 **

OSTK broke support at $42 and is poised to accelerate to the downside. With earnings ahead I like the current trend. CIBC and RBC Capital both initiated coverage last week with an "under perform." Earnings will be released on April 22nd.

Overstock.com is poised to repeat the Amazon story. They rallied to the excess peaks on the story and promise of the future and are now finding it difficult to follow through on that promise.

For a complete and lengthy explanation of this play please refer back to the April 3rd edition of the LEAP newsletter.

I believe Overstock.com will return to its $20 roots and with earnings just ahead we could easily have some negative surprises. Unfortunately they don't have leaps but we can still play with September puts. I realize many readers may not have the same incentive to short OSTK that I do and I understand. However, looking at a chart should suggest to you that others have found them lacking as well.

September $40 Put QKT-UH @ $5.70

No insurance call due to prices out of range.
Use a stop at $48 instead.

Entry $42.60 (04/04)

SMH - $29.93 Semi Holders ** Leap Dropped, retain put **

Warnings in the chip sector and the IBM earnings miss wiped out any chance of a SMH rebound. I am closing the call side and leaving the PUT side open. If Intel trips on Tuesday we could have a home run to the downside.

Semiconductors have been the only strength sector for techs and we are rapidly running out of time for any real rebound. If techs do not rebound over the next two weeks I plan on closing this play for non-performance. I don't want to hold it into the summer doldrums.

2006 $35.00 LEAP Call YRH-AG @ $2.75, closed $1.40, -1.35

Insurance put:
May $30 Put SMH-QF @ 45 cents, currently $1.15, leave open
Set a stop loss at $30 on the SMH. If Intel disappoints we could be headed for $28.

Entry $33 (03/15)

ADBE - Adobe Systems $67.18 ** Stopped $66.50 **

Adobe is still holding its gains but I am getting even more nervous. I raised the stop to $66.50 and I am hoping for a Nasdaq rebound to hit our profit target at $69. We came within 11 cents on Wednesday. I am maintaining that profit stop at $69.

Adobe is the king of the document and image business and continues to announce new products. The company announced earnings in December that rose +33% and beat estimates. Income for the year rose +69% on a +29% increase in revenue. Adobe affirmed guidance for 2005 and the stock has been beating the Nasdaq in percentage gains. In 2004 the stock rose +60%. Since they have already announced earnings we have very little event risk over the next month.

I recommended the February $55 put as insurance at 80 cents. That gave us six weeks for the Q1 earnings to cycle and for ADBE to pick a direction. If we are not profitable by Feb-18th expiration we will close and take our lumps.

Jan-06 $60 LEAP WAE-AL @ 7.50, exit 11.90, +4.40, net +2.85

Put Insurance
Feb-05 $55 Put AEQ-NK @ 80 cents - expired worthless

Added new insurance on Feb-22nd
Mar-05 $60 Put AEQ-OL @ 75 cents - expired worthless

Stop loss $66.50

Entry $58.78 (01/09)

SYMC $18.89 Symantec - Veritas ** Close LEAP, retain put **

SYMC broke support at $20 on Friday and I am throwing in the towel. The strong drop on Friday was due to a 10K reporting large stock sales by officers. The sales were according to 10B5-1 rules but the evidence of selling prior to the May-4th earnings was a red flag to many.

We will close the LEAP, currently $2 for a $4.30 loss. After accounting for the two insurance puts that loss drops to -2.25 if everything was closed today. Considering the worsening of sentiment on SYMC, officers selling ahead of earnings we could see $16. I want to keep the July $22.50 put open with an exit target of $16.25. This should come very close to a breakeven on the position. This is not how I want to breakeven but it is better than a loss any day.

Leap $6.30+
Exit $2.00
Loss $4.30-
Aput $0.80+
Jput $1.25+ as of Friday
Loss $2.25- as of Friday, target $16.25 to exit.

2007 $25 LEAP Call OBL-AE @ $6.30, exit $2.00

Insurance Put
APR-2005 $22.50 PUT SYQ-PX @ $1.15, closed 4/11 $1.95
JUL-2005 $22.50 PUT SYQ-SX @ $2.75, opened 4/11

Entry $25.37 (12/19)


Leaps Trader Watch List

The long awaited drop in oil prices has finally arrived. Oil fell to $50 and stalled on Wednesday and appears to be holding that level. We had two energy plays triggered and it was not the two I expected. The refiners VLO and PCO both fell off the cliff created by the refinery outages in the past month. Both had soared and I was beginning to think they would never come back to earth.

I also entered on the XLE as it was only a few ticks away from our entry point and as an index play should begin to rebound slightly before the individual stocks. Any 3-5 in the XLE could push it higher while the rest wander at support.

On the major oils, COP, OXY, XOM, we were not triggered but we are close. I lowered the breakout entries to a couple dollars over the current price and lowered the breakdown entries slightly just in case we get another leg down in oil prices. I would take them here but there is no reason to rush. Oil prices held at $50 for the last three days but oil stocks continued lower as funds sold to cover cash withdrawals by fund holders to make tax payments. I may be pressing my luck hoping to get a couple more dollars of drop on COP and company but even if we hit the breakout a couple dollars higher it is not a bad entry. It is up to you to decide when you enter and any entry here is dynamite compared to the highs from last month.

Just remember that there is no firm bottom. We could still drift lower as the Q2 demand slump allows inventories to build. Once gasoline production accelerates those inventories will shrink and the race higher will begin again.

I wanted to add Total Sa to the watch list but they have no Leaps. They have pulled back to their 100-day average and look like a strong buy as it has always held in the past. I looked at the options and November was the farthest month. The Nov-$115 looked good at $5.10. TOT was $122.75 just last month. I heard two analysts commenting that even at $120 it could rise $20-$25 and still be undervalued. If you want to play it that is the way I would do it. If you do play it let me know and I will post more "non leap" tidbits as I see them.

We (I) missed the DJX put entry last week by 21 Dow points. I was targeting 10550 and we only hit 10529. Close but no cigar. Hopefully some of you jumped in anyway. I am dropping it for obvious reasons.

Dropped Entries

New Watch List Entries


Current Watch List

COP - Conoco Phillips
OXY - Occidental Petroleum
XOM - Exxon Mobil


COP - $100.03 Conoco Phillips

** Breakdown Target $98.00 **
** Breakout Target $103.00 **

Conoco is my first choice for an oil stock once the current trend eases. I would like to get an entry around the 100-day average now at $97 and rising. This has been a good support level in the past.

Breakdown entry: BUY 2007 $100 LEAP Call OJP-AT
Breakout entry: BUY 2007 $110 LEAP Call OJP-AB


OXY - $65.50 Occidental Petroleum

** Breakdown Target $63.00 **
** Breakout Target $68.00 **

OXY would be my next choice with the same 100-day average as an entry point. That is currently $63.50.

Breakdown target: BUY 2007 $70 LEAP Call VXY-AN (no $65)
Breakout target: BUY 2007 $70 LEAP Call VXY-AN


XOM - $56.11 Exxon Mobil

** Breakdown Target $55.00 **
** Breakout Target $58.00 **

XOM has larger reserves and more cash than any other oil company. They have to find something to do with their $28 billion and it will either be returned to the shareholders or used to buy more reserves.

Breakdown target: BUY 2007 $55 LEAP Call ODU-AK
Breakout target: BUY 2007 $60 LEAP Call ODU-AL



Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

To ensure you continue to receive email from Option Investor please add "support@optioninvestor.com"

Option Investor Inc
PO Box 630350
Littleton, CO 80163

E-Mail Format Newsletter Archives