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Weekly Newsletter, Saturday, 05/07/2005

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Table of Contents

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

Leaps Trader Commentary

Nice Bounce But Now What?

Not a bad week for the watch list with both positions, FNM and APC, filled in just about the best possible way. However, I missed a nice exit on Wednesday when GM shot up to $33.20. It would have been a great place to exit our May insurance call.

The rebound in oil prices helped lift our oil stocks back out of their depression but I seriously doubt we have seen the lows for the quarter. The summer demand has not yet hit inventories and they are still building. Once they start to decline the real fun will begin.

For the coming week we still have a very full portfolio and the airline shorts are not working as planned. With oil holding around $50 there are comments nearly every day that $40 oil will return. This is keeping the airlines on life support along with their new fuel surcharge fees. Both JBLU and CAL are at resistance so we will either be proven right or be stopped out very soon.

I hesitate to add any new positions until I lighten the load. I am trying to maintain the portfolio to a maximum outlay of $10,000 for one contract of every position including the insurance. The addition of FNM and APC this week puts us over that level and for those traders on a budget I would dump the airlines to add these positions.

With the summer doldrums approaching quickly I hesitate to add any new entries to the watch list but there was one I could not resist.
 


Changes in Portfolio

New Plays
None

Dropped Plays

None


New Watch List Plays Triggered
FNM $54.94 Fannie Mae
APC $73.81 Anadarko Petroleum

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

FNM - $54.95 Fannie Mae ** No Stop **

We were triggered on our short entry on Fannie Mae on Wednesday when FNM spiked through our $55 trigger point to $55.70. There is a gap at just over $56 that was nearly filled on Thursday.

Stronger jobs would mean more home loans for FNM but also higher rates from the Fed. That is not the problem we fear. Regulators are increasing their attack on the entity and Greenspan reiterated his warning on May-5th. He wants Congress to limit the multibillion-dollar holdings of FNM/FRE and warned again that any major problem with either could severely damage the U.S. markets. He favors allowing them to only hold the minimum level of mortgages as required by their charter. This would be a drastic cutback from current levels.

Fannie Mae has been suffering from numerous ailments including accounting problems. The regulator for FNM has asked for more power to dig deeper. We suspect any deeper digging could turn up some more skeletons.

2007 $50 LEAP Put VFN-MJ @ $5.40

Insurance Call
June $55 FNM-FK @ $2.00

Entry $55 (5/04)

APC - $73.81 Anadarko Petroleum ** No Stop **

APC dropped sharply on Tuesday and followed with a continued dip to the 100-day average on Wednesday. That dip to $70.50 triggered our long entry and provided a nearly perfect double bottom with the April 18th dip to within a nickel of the same level. This was about as good an entry as we could have scripted and I know from reader email several of you took advantage of it.

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.

Anadarko has just completed a restructuring program and raised estimates on May-2nd. They expect output to rise +5% in 2005 and costs to be below industry trends. S&P is estimating $8.55 for earnings in 2005 and a price target of $85.

2007 $75 LEAP Call OCP-AO @ $10.10

Insurance Put
June $65 APC-RM @ $0.85

EEntry $70.50 (5/04)


Play Updates

Existing Plays

COP - $104.92 Conoco Phillips ** No Stop **

COP continues to benefit from good press and their aggressive outlook. They are holding well above their 100-day average at $99.50 and are showing much more strength than XOM.

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.


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 - $70.35 Occidental Petroleum ** No Stop **

OXY is beginning to move away from its averages and is developing an upward bias like COP. As long as oil remains over $50 we are in good shape. They declared a quarterly dividend of 31 cents this week and appointed former U.S. Secretary of Energy, Spencer Abraham, to their board. Earnings in 2004 were a record $2.6B and as the CEO pointed out on Friday it was more than a billion more than they earned in 2000. Not a bad growth record. Q1 earnings were up +74% over Q1-2004.

OXY reported earnings on April 26th 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 reported an agreement with Oman to invest $2B in the Mukhaizna oil field and upgrade production from 10,000 bbls per day to 150,000 per day. I would happily invest $2B once to get $3B return per year. Good job!

OXY is the 239th largest company in the world and an oil giant.
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.

2007 $70 LEAP Call VXY-AN @ $10.00

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

Entry $68.00 (4/19)

XOM - $57.62 Exxon Mobil ** No Stop **

XOM may have found a bottom at $56 after testing it three times in recent weeks. This corresponds with its 100-day average at $56.38, which was support in the past. There is a down trend line just above the current level that is going to cause trouble if oil prices remain stuck at $50. I don't like XOM as much as COP and OXY but this is the right place for a goal line stand.

XOM reported a +44% jump in earnings last 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.

2007 $60 LEAP Call ODU-AL @ $6.70

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

Entry $58.00 (4/19)

XLE - $41.14 Energy SPDR ** No Stop **

The XLE is also using the 100-day average as support. As long as oil remains over $50 we are in good shape.

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 @ $5.60

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

Entry $39.75 (4/18)

VLO - $67.72 Valero Energy ** No Stop **

VLO is holding support at $64.50 after the announcement it was buying Premcor. We saw a significant drop after the announcement but the weakness appears to be fading.

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

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

Entry $68.00 (4/15)

CVX - $52.68 Chevron Texaco ** No stop **

Chevron spiked to $54.50 on Friday on news of an oil find in Utah by Wolverine where Chevron has extensive leases. It was also announced that Chevron had won a portion of the 15 blocs up for bid in Libya.

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 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 - $20.78 Jet Blue ** New Stop $22.50 **

JBLU still fighting resistance at $20.50-21.00 but lower oil prices could continue to give the sector a lift. The 200-day average is currently $21.50 and I am placing a stop $1 over that level. The lower oil is not helping the airline puts.

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 - $23.17 TOO Inc ** Stop Loss $24.50 **

TOO also appears to be trying to form a bottom on the 200-day average at $22.50 but the rebound has been weak. Should the market weaken again I believe it will fail.

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 several 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 @ $2.05

No insurance call.

Entry $24.22 (4/10)

GM - $30.80 General Motors ** No Stop **

GM got a huge pop from the obviously self-serving Kirk Kerkorian tender for 28 million shares at $31. GM was trading at $27.50 when he announced the tender. What idiot would tender for $31 when he could buy all he wanted at $27? An idiot who already owned 22 million shares and wanted to make a cool $4 bucks on the pop. Maybe Kirk was sly like a fox rather than dumb like a beginner trader. Now he can unload his shares and cancel his tender for a nice profit.

I was out of the office when the spike to $33 occurred or I would have jumped on the chance to sell the call for a $3 profit. I hope a few readers did not let that opportunity pass them by.

I am going to close the May $30 call today, currently $1.25, and go naked on the LEAP put. We will add a stop at $33.50, which is over the level reached on the spike.

For those who believe as I do that GM with its $200 billion in debt and growing will eventually break $25 to the downside I would suggest doubling up at this level. Ironically the put is worth more today than when we entered at a lower level back in April.

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

Insurance Call
May $30 Call GM-EF @ $1.50, exit 5/08 $1.25, -0.25

Entry $29.35 (4/04)

CAL - $12.79 Continental Airlines ** Stop $13.50 **

CAL rebounded +1.50 on Tuesday after announcing that passenger traffic increased +6.6% over the same period last year. I doubt this has translated into higher profits given the cost of fuel but it did translate to another stall at $13.00. It has held that level for three days. I am leaving the stop at $13.50 and we will exit it hit.

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 $34.84 Overstock.com ** Stop loss $39.00 **

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

No news and no bounce. Exit on a touch of $30 and potential support. I lowered the stop to $39.

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.
Use a stop at $42 instead.

Entry $42.60 (04/04)


Leaps Trader Watch List

With summer fast approaching and our portfolio looking more like an energy trust than a balanced investment I hesitate to add any new positions.

However, there was one more energy company that seems to have a compelling story ahead. I added Chesapeake Energy to the watch list with a target of $19.

I wanted to add BNI, Burlington Northern, but felt we already had too many energy plays. I am mentioning it here for those who want some more targets. BNI is making a mint off the transportation of coal. The U.S. is the Saudi Arabia of coal with Canada a close second. With the current drain on natural gas supplies coal will eventually be the number one fuel in the U.S. BNI can't order coal cars fast enough and shipment of other commodities like lumber, chemicals, ores and building supplies are also accelerating. As gasoline becomes more expensive the railroad will become the preferred transportation method for many more products. The Jan-2007 $55 calls are cheap at $6.20 and it traded over $55 as late as March. I would use a stop of $44 and no insurance put.

If you see any obvious LEAP plays that could work through the summer please email them to Jim at Option Investor and I will post them for everyone to see. Until the portfolio slims down to 10 positions or less I will be keeping a skinny watch list but continue to comment on stocks I like.
 

Dropped Entries

None


New Watch List Entries
CHK
$20.00
Chesapeake Energy

CHK - $20.00 Chesapeake Energy

** Breakdown Target $19.00 **
** Breakout Target $21.50 **

Chesapeake Energy derives 90% of its revenues from natural gas. They are very aggressive about replacing reserves and will capitalize on the continued increase in prices. Gas prices have soared in the U.S. due to the addition and conversion of electric plants to the cleaner fuel. Several times over the last winter the gas levels supplying those plants dipped to dangerous levels. The demand is increasing faster than supply and the production peak is now estimated to be 2007. Prices are going to continue higher, much higher and Chesapeake is positioned to benefit.

This summer much of northern California will get its electricity from gas due to a drought in the northwestern hydro-electric grid. Generation levels will be below normal and natural gas is the fall back power.

Breakdown Target
BUY 2007 $20 LEAP Call VEC-AD currently $4.60

Breakout Target
Buy 2007 $22.50 LEAP Call VEC-AX currently $3.70

No insurance put - Stop at $16.00
 


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