Table of Contents
Leaps Trader Commentary
The range bound market may have been producing alternating triple digit days but for our portfolio it was boring. Oil stocks reported earnings that increased exponentially but analysts were still unsatisfied after marking up estimates almost daily for the quarter.
The only real excitement for the month was the buyout of Premcor by Valero. PCO spiked from $59 to $73 on the news and our leap soared right along with it. I suggested an exit in the Market Monitor at the time to capture the maximum premium. I repeated that recommendation in my Tuesday night market wrap. In the future I will be sending an alert email when we have unexpected news impacting a position.
After reaching a high of nearly $56 last Friday oil prices fell off a cliff only a week later and closed at $49.72 this Friday. This is exactly the 100-day average and a strong buy level. I believe the Friday sell off was related more to end of month portfolio rebalancing, tape painting and expiration of contracts in heating oil and unleaded gas than just a new trend beginning. However, we need to realize that this is the slowest demand period of the year and we could easily retreat further to the 200-day average at $47 or even lower. I believe every dip under $50 is just a better buying opportunity for long term traders. Near term volatility is guaranteed but that is why we buy insurance with the puts.
I considered a long entry on Martek (MATK) after the beating they took on Thursday but they have no leaps. For those who want to roll the dice I believe the sell off was way overdone and we should see a nice rebound into year-end. First Albany provided us with an example of coverage confusion this week. They downgraded MATK to Neutral from Buy back in March. When the news hit this week they downgraded them to underperform from neutral on Thursday. On Friday they upgraded them to a Buy. Sounds like they exited their shorts on the dip and went long.
I am not adding any new plays this week. The market can't decide which way it wants to go and I still believe the path of least resistance is down. We have plenty of positions and I would rather be adding to oil on the dips than trying to cover all the sectors with a token play.
I did add Anadarko Petroleum to the watch list as a potential takeover
in the oil sector.
Changes in Portfolio
Portfolio Listing & Top Picks
COP - $104.85 Conoco Phillips ** No Stop **
COP rose +2.09 on Friday despite the drop in oil to close below $50. COP is continually listed as the best play on integrated oils and I believe it. Earnings from several oil companies, including XOM, failed to please analysts because of hedging programs in place. XOM sold futures to lock in the "high" oil prices and then got locked out when prices went higher. I would continue to add to any long-term COP positions on any dip.
COP reported earnings of $4.10 that rose +80% over the year-ago period. Analysts had only expected $3.29. They said unplanned down time at refineries kept them from doing even better. They also said they were going to spend $3 billion between 2006-2010 to increase their ability to handle the cheaper sour crude.
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.
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 - $68.99 Occidental Petroleum ** No Stop **
OXY reported earnings on Tuesday of $2.16 per share compared to estimates of $1.99. OXY said it had higher than expected production, strong pricing and record chemical sales. Still it failed to produce the blowout earnings of COP due to hedging.
OXY is the 239th largest
company in the world and an oil giant.
Entry $68.00 (4/19)
XOM - $56.99 Exxon Mobil ** No Stop **
XOM reported a +44% jump in earnings this week but missed analyst estimates. After items XOM earned $1.15 and analysts were expecting $1.20. XOM hedged to capture high oil prices and prices continued to move higher. They also saw a drop in production as mature fields continued to decline. XOM said it will spend $15-$16 billion in capex in 2005 in an effort to discover/produce more oil. They also said they were going to buy back $3.5 billion in stock in the current quarter. Their record profits of $7.86 billion for the quarter give them plenty of cash for anything they desire. Maybe a couple acquisitions would help that sagging production.
XOM has larger reserves and more cash than any other oil company. They have to find something to do with their $30 billion and it will either be returned to the shareholders or used to buy more reserves.
XOM is the largest oil company in the world and while it has the largest reserves it also has the highest overhead cost.
XLE - $40.55 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
Entry $39.75 (4/18)
VLO - $68.50 Valero Energy ** No Stop **
VLO announced on Monday that it was buying independent refiner Premcor, another stock we had in the portfolio. VLO saw an initial bounce in the market but acquisition jitters sent it plunging before the week was over. VLO has retraced quite a bit but continues to hold over support at $66.
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. 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 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
Entry $68.00 (4/15)
PCO - $66.31 Premcor ** Closed 04/25 on buyout news **
PCO announced on Monday that it was being bought by Valero and the stock shot up to $73 on the news. I recommended in the monitor that we close the play due to the upside being capped by the acquisition. The Leap was trading at $18 the time with bid/ask jumping around between $16 and $21 with a lot of volatility. I repeated that recommendation in my Tuesday night wrap with prices around $13. Our entry was $9.60.
In the future I will send out a special alert if we have news of this type that impacts out positions.
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.
2007 $60 LEAP Call VJE-AL @ $9.60, exit $16.00 (low bid)
Insurance put: June $50.00 PCO-RJ @ $1.95, exit .50
Entry $56.00 (4/15)
CVX - $52.00 Chevron Texaco ** No stop **
Chevron posted earnings that disappointed the street due to several unplanned outages at various refineries. CVX saw refining profits fall -36% but the condition is expected to be temporary. The stock is also weak due to uncertainties about the Unocal acquisition.
Chevron broke support at $52 but returned to that level at Friday's close. This is still a level that should hold unless crude begins to collapse. Several brokerages have issued positive comments about this being a buying opportunity for CVX.
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.
Entry $56.67 (04/07)
JBLU - $20.04 Jet Blue ** No Stop **
JBLU still fighting resistance at $20.50 but lower oil prices could give the sector a lift. We need for the next leg down to begin soon and once into May I expect the markets to weaken. This could give us the opportunity we are looking for.
JBLU spiked to resistance 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 - $22.91 TOO Inc ** Stop Loss $25.50 **
TOO set a new low on Friday and appears to be weakening. A break under the 200-day average at 22.24 could really get things moving.
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 - $26.65 General Motors ** No Stop **
GM rallied back over $26 but is still well under the current down trend resistance. Resistance at $27 is still holding and the only thing GM has going for it is the temporary drop in oil. 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 @ $7.20
Entry $29.35 (4/04)
CAL - $11.80 Continental Airlines ** Stop $13.50 **
CAL set a new low for the month on Friday but the end of day tape painting returned it to near $12. Cheaper oil could help CAL but my long-term outlook is still the same. Lower stop to $13.50.
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.
Entry $12.00 (03/31)
OSTK $35.27 Overstock.com ** Stop loss $42.00 **
**** PROFIT TARGET $30.00 ****
No news and no bounce. Exit on a touch of $30 and potential support.
OSTK imploded on April-22nd 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.
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.
Entry $42.60 (04/04)
Leaps Trader Watch List
After the spectacular jump in Premcor on the Valero buyout I started looking for additional candidates in the energy sector. The best target I saw this week was Anadarko Petroleum (APC). Anadarko was a strong performer when they released earnings last week with a +25% increase in profits that beat analyst estimates.
The company is based in Houston and it announced last week a new deep water discovery in the Gulf of Mexico. This discovery could add +2% to +3% of reserves to Anadarko's already diverse holdings. According to APC they have proven reserves of 2.37 billion barrels. Anadarko has oil and natural gas operations in the United States, Canada, Tunisia and Algeria, as well as deep sea platforms in the Persian Gulf, the Black Sea, the North Atlantic and the Gulf of Mexico. They have oil assets outside the U.S. and gas assets inside the U.S. which is exactly where they need to be.
They are now the largest independent in a field of giants. Still Exxon could write a check for them should they decide they are ripe for an acquisition.
I am adding them to the watch list on the hopes that another dip in oil will
give us a better entry. If we didn't already have some underwater oil positions
I would take the entry here at $72.86.
Current Watch List
FNM - $53.95 Fannie Mae
APC - $72.86 Anadarko Petroleum
FNM - $53.95 Fannie Mae
** Breakdown Target $51.50 **
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
APC - $72.86 Anadarko Petroleum
** Breakdown Target $70.50 **
Anadarko has 2.37 billion barrels of proven reserves. They are the largest independent in a field of giants. Buying reserves is cheaper than finding them.
Buy Insurance Put June $65 APC-RM currently $2.15
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