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Weekly Newsletter, Saturday, 04/23/2005

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Table of Contents

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

Leaps Trader Commentary

A Return to Serious Volatility

We thought the prior week was exciting but it only seems to get better in terms of increased volatility. The good news was a fill on three more oil plays and a serious breakdown in OSTK.

The dip in oil prices last week gave the airlines some lift and the rebound in oil this week has yet to push them lower. The big short covering rally on Thursday also floated all boats and planes and we have yet to see the tide go back out.

Having all the remaining oil plays triggered on the watch list left it empty and with summer ahead of us I could not see adding any new calls. I did come up with a couple new puts for your approval.

The volatility in the market place would be good if we were trying to sell something as it increases the prices of options. Unfortunately it also makes it hard to pick plays or rationalize what is happening to the current ones. Earnings season can cause serious zig-zags in prices as other stocks surprise investors with different results. That is exactly what we are seeing now.

I believe that the Dow will eventually break 10,000 and 9800 will return as critical support. This does not mean we are going straight down but I do believe the summer will be choppy with a downward bias similar to 2004. The only difference may be a little sharper drop to start the process as we have already seen.

Now that we have a relatively full portfolio I am going to be much more particular with future entries until an upward bias returns or we achieve what I believe to be a bottom as we approach the end of summer. Leaps traders (as opposed to investors) should be ready to enter numerous positions towards the end of summer and early fall. That is historically our prime time for profitable entries.

Since the oil plays are basically all the same, geared to an increase in crude oil as the year progresses, I am not going into a lot of detail on each individual entry.
 


Changes in Portfolio

New Plays

 None

 

Dropped Plays

 None

 

New Watch List Plays Triggered
COP
$106.90 Conoco Philips
XOM $59.42 Exxon Mobil
OXY $71.34 Occidental Petroleum

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

COP - $106.90 Conoco Phillips ** No Stop **

Conoco is my favorite oil stock and we got a really nice entry on Monday when the market reopened from the Friday crash. Evidently there were lots of sell orders in the queue and they flushed right to our entry point at $98. I considered not using an insurance put given the distance from our entry but there is still risk that we will return to the 100-day average again. I am going to spend the money on the put in hopes that should we return to the 100-day average we can sell it to reduce our costs in the call. I do not foresee closing the call before December but we always need to be careful.

Helping to produce the rebound was news from Venezuela that Chavez had misspoke when he said the tax rate was going from 34% to 50% on the Orinoco oil contracts. This caused a sharp drop in XOM, COP, TOT and CVX when it was initially announced. When the announcement was corrected and qualified all four major oils rebounded sharply.

COP has been aggressively purchasing assets around the globe and especially in Russia. Putin has said repeatedly that COP assets and agreements are not at risk and that COP is a partner with Russia in producing their oil.

COP has earnings on April 27th and is expected to report the strongest EPS growth of any major oil at +43%.

2007 $100 LEAP Call OJP-AT @ $15.77

Insurance put:
June $100 COP-RT currently $2.15

Buy the put insurance only if you feel you need it. We are far enough away from the entry point that I feel relatively safe.

Entry (4/18 $98.00)

 

OXY - $71.34 Occidental Petroleum ** No Stop **

OXY is the 239th largest company in the world and an oil giant. When they report earnings on Tuesday they are expected to report earnings of $1.98 a share compared to $1.23 in the prior year.

Occidental's principal activities are to explore for, develop, produce and market crude oil and natural gas. The operations are carried out through two segments: Oil and Gas and Chemical. The Oil and Gas segment develops, explores for, produces and markets crude oil and natural gas. The Chemical segment manufactures and markets basic chemicals. The company operates primarily in the United States, Qatar, Yemen, Colombia, Oman, Pakistan, Canada, Russia, Ecuador and the United Arab Emirates.

Earnings April 26th before the open.
Conference call 11:AM. Http://www.oxy.com

2007 $70 LEAP Call VXY-AN @ $10.00

Insurance Put:
June $65.00 OXY-RM currently $1.40

Entry $68.00 (4/19)

 

XOM - $59.42 Exxon Mobil ** No Stop **

XOM dipped to $55.40 on Monday and missed our breakdown entry target of $55 by 40 cents. We were lucky enough to get in on the breakout at $58 when the rebound began. It probably cost us a buck in lost gains but as long as oil continues higher we should be in good shape. XOM actually touched its 100 day average on Monday and gave the clearest entry signal. XOM also has the most pronounced downtrend from the March highs. This trend needs to reverse soon or another test of the 100 day average could result.

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. They could announce some distribution of that cash with earnings on Thursday April 28th. They are expected to earn $1.20 per share.

XOM is the largest oil company in the world and while it has the largest reserves it also has the highest overhead cost.


2007 $60 LEAP Call ODU-AL @ $6.70

Insurance Put:
July $55 Put XOM-SK currently $1.20

Entry $58.00 (4/19)

 


Play Updates

Existing Plays

XLE - $42.04 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.

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)


 

VLO - $75.04 Valero Energy ** No Stop **

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
 
Valero reported earnings on April 21st of $1.92 that more than doubled the prior year of $.91 cents. VLO fell slightly in trading because analysts had estimates of $1.97. Shucks, they missed estimates by a nickel but more than doubled last year. Let's sell them. Duh! They rebounded as eager traders rushed into the gap and they closed at $74.86 on Friday, more than $5 above the earnings dip at $69.55.

2007 $75 LEAP Call VHB-AO @ $14.10

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

Entry $68.00 (4/15)

 

PCO - $59.10 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.

Premcor will announce earnings on Thursday April 28th.

2007 $60 LEAP Call VJE-AL @ $9.60

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

Entry $56.00 (4/15)

 

CVX - $53.83 Chevron Texaco ** No stop **

Chevron found support at $52 and made a nice double bottom there at the 200 day average over the last two weeks. The Unocal news is fading and we are approaching earnings scheduled for Friday the 29th. Chevron is actually expected to have the weakest earnings growth of the majors due to the lower prices for heavy crude. They have also had several refinery outages in recent weeks. I view the weakness in CVX as a buying opportunity.

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.

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

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

Entry $56.67 (04/07)

 

JBLU - $20.05 Jet Blue ** No Stop **

JBLU spiked to resistance at $20.50 once again when it reported earnings that were less than half the same period last year but were still slightly ahead of reduced estimates. JBLU reported +6 cents, +3 cents ahead of estimates but well below the +14 cents for the same quarter last year. Revenue rose from #289 million to $374 million. The main reason for the profit drop was higher fuel prices. They spent $86.6 million for fuel in the last quarter compared to only $49 million for the same period in 2004.

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 - $23.73 TOO Inc ** Stop Loss $25.50 **

TOO rallied back from last weeks four month low on a Merrill upgrade. TOO rallied to resistance at $25.25 but promptly began fading once again. It fell back to the prior support at $23.50 and closed just over that level on Friday. Ironically Merrill had downgraded them only three weeks ago. I guess they covered all their shorts and reversed to long positions.

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 three weeks ago 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 - $26.76 General Motors ** No Stop **

GM rallied back over $26 but is still well under the current down trend resistance. No change in outlook in my opinion.

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 - $11.90 Continental Airlines ** Stop $14.50 **

CAL closed near the lows for the week and on the verge of breaking support at $11.75. If oil continues higher CAL should continue lower.

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 $34.15 Overstock.com ** Stop loss $42.00 **

**** PROFIT TARGET $30.00 ****

OSTK imploded on Friday after reporting a loss that nearly doubled the same period last year. OSTK reported a loss of -21 cents when analysts were expecting a loss of -12 cents. Expenses were skyrocketing and red ink showing everywhere. Exit on a touch of $30 and potential support.

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)

 


Leaps Trader Watch List

The Monday morning drop in oil gave everyone targeting the XLE entry a pleasant surprise. COP, another watch list candidate also fell to our entry point. Actually, the entry point was $98 and it fell to $98.01 but I am sure anyone watching and waiting took it anyway.

The rebound from $50 oil sent shares of the rest of the candidates soaring and triggered the XOM, OXY entries on the breakout. This leaves us with a very light watch list and a weak market.

I am only adding one stock this week and that is FNM. With the continuing horror stories, the Fed still raising rates and the potential drop in home sales and defaults in mortgages they are a potential disaster. Given their huge derivative exposure a drop in volume could upset the applecart.

I don't want to add a big watch list as we enter the weakest time of the year. We currently have a large PUT portfolio and we are heavy in energy stocks. In theory we are poised to make money in both directions as rising oil should depress the markets.
 

Dropped Entries  
None

New Watch List Entries
FNM
Fannie Mae

Current Watch List

FNM - $52.84 Fannie Mae

** Breakdown Target $51.50 **
** Breakout Target $55.00 **

Fannie Mae has been suffering from numerous ailments including accounting problems and the early April rebound has failed and it appears we are about to start a new leg down. The regulator for FNM has asked for more power to dig deeper.

BUY 2007 $50 LEAP Put VFN-MJ currently $7.00

Buy Insurance Call June $55 FNM-FK currently $1.75  


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