Leaps Trader Commentary
After getting a small bounce early in the week, oil dropped to a new low of $46.20 on the June contract. Starting Monday we'll be switching to the July contract. There is a steep down-channel that has contained price action in its decline from the March high. After bouncing off its 200-dma ($47.60) and its long term uptrend line, oil then dropped below this support to end the week below its 200-dma. However if you look at the July contract, its 200-dma and uptrend line sit near $47.00. This contract closed at $48.65 on Friday and therefore has another $1.65 that it can drop before reaching firmer support.
The continued drop in oil has continued to depress the price of the oil stocks as well. The oil index dropped below its 100-dma at 444.73 last week and then bounced back up to it before dropping back down and closing at 440 on Friday. This index looks like it could be headed for its 200-dma support at 417.01 but could find support at its uptrend line from December 2003, currently near 423. A little further drop would coincide with a further drop in the price of oil as noted above. This index looks close to solid support and therefore anywhere in here makes for a good entry level for the oil stocks. I set some exit targets for the insurance puts so that we can use those profits to reduce our costs in the LEAP calls.
These insurance puts continue to protect us to the downside but we could be close to support and will watch carefully for where we'll want to take profits on the puts so as to decrease our cost in the LEAPs. The US dollar continued its rally this week and that has depressed the prices of most commodities. The dollar looks like it has at least a little more rally left to it which again fits the picture that we could see a little further dip in the price of oil.
The broader equity market enjoyed a very nice rally off the May 13th low. The rally is looking tired now and I would expect to see a pullback early in the week. The DOW and S&P had dropped below their long term uptrend lines (from March 2003) in April and are now coming back up for a test of that trend line. We'll watch this carefully to see if it will just consolidate below it and rally above or instead starts to pull back more aggressively. If we start to drop back down quickly, we could see a test of DOW 9800 sooner rather than later.
The only change to our portfolio this week was the drop of OSTK since it rallied up and hit our stop. I still view this stock bearishly but I didn't want to see a profit turn into a loss on this one. As always, price rules, not my opinion.
I updated several cautionary exits on the insurance puts on oil. If we do get a
continued drop I want to take profits on the puts and reduce our costs in the
Changes in Portfolio
Most Recent Plays
CHK - $19.28 Chesapeake Energy ** No Stop **
CHK dropped down to its 200-dma which would have been an ideal entry point but at least price has since bounced back up above our entry point of $19. CHK has not violated the 200 since July 2002 and that record is still holding. Hopefully we will not need the insurance put but it is worthwhile insurance until we see oil recover.
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.
Insurance put: July $17.50 CHK-SW @ 90 cents
FNM - $56.72 Fannie Mae ** No Stop **
FNM got some press this week but not the kind it would like. Greenspan issued a warning to Congress that the unrestrained growth in FNM's (and FRE's) mortgage portfolios needs to be reined in. This is not bullish for FNM but it still rallied with the broader market back up to its resistance just under $57. If the market pulls back in the coming week, this stock should also pull back again from its resistance.
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.
Entry $55 (5/04)
APC - $72.29 Anadarko Petroleum ** No Stop **
APC came down for a perfect test of its 200-day average. This has been strong support since 2003 and held again. Price then immediately bounced back above its 100-dma so it looks like a good test. Now we need to see price make a new high since each bounce since the March high has created a lower high.
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.
Entry $70.50 (5/04)
COP - $101.11 Conoco Phillips ** No Stop **
COP got a bounce with the other oil stocks without dropping to its 200-dma first. It has closed essentially on top of its 100-dma and therefore any weakness from here could see a drop to test its 200-dma at 91.70. I'm expecting that support level to hold and will exit the insurance put if $92 is touched.
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 - $68.04 Occidental Petroleum ** No Stop **
OXY looks a little stronger than the others in that it bounced off its 100-day at $66 and has continued to hold above it on a closing basis. If it does drop below its 100-dma, the next support would be the 200-day at $60.79 and like COP we'll close the insurance put just before this level at $61.
OXY declared a quarterly dividend of 31 cents in early May 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.
Entry $68.00 (4/19)
XOM - $56.80 Exxon Mobil ** No Stop **
XOM did a perfect bounce off its 200-dma as the fund managers used that as a signal to add this stock to their portfolio. Price could bounce around on the 200-dma just as it did on top of its 100-dma and if it ultimately breaks, watch for support in the $50-$52 range at the previous price congestion. Based on that stronger support we will close the insurance put with a touch of $51.
XOM reported a +44% jump in earnings 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 - $39.65 Energy SPDR ** No Stop **
After breaking below its 100-dma XLE bounced even before it reached down to its 200-dma at $37.46. It's currently finding resistance back up at the 100-dma at $40.37. The $39 insurance put will protect us if it drops a little lower before finding stronger support at the 200-day at $37 or previous price congestion around $36. We'll cover the insurance put with a touch of $36.
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
Entry $39.75 (4/18)
VLO - $65.19 Valero Energy ** No Stop **
After breaking below price level support at $65 VLO has bounced back up for a retest of this level. It remains to be seen if it will regain this level or get another pullback. It is holding above its 100-dma which makes it look stronger than the others but it may still experience a further pullback if the other oil stocks suffer a little more weakness. If VLO drops down a little further it will close its February 1st gap at $52 which is just above its 200-dma at $51.71. Therefore we will close the insurance put at $52 if touched.
VLO has been weak since the announcement it was buying Premcor. This should be a very good deal for them and the combined companies will control a large portion of the refinery business. Think of it as a buying opportunity.
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.
Entry $68.00 (4/15)
CVX - $51.72 Chevron Texaco ** No stop **
CVX has been fighting to stay above price level support at about $50.50 and got a bounce back above this line this past week. If CVX is pulled down by any further selling in oil and the oil stocks, there could be strong support at the previous price congestion around $48 and the insurance put at that level would be close to giving us a free LEAP play. Therefore we will exit the put with a touch of $48.
Chevron spiked to $54.50 on May 6th 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.
TOO - $19.50 TOO Inc ** Stop Loss $22.50 **
After breaking its 200-dma at $22.54 TOO made a feeble attempt to retest it but failed quickly and dropped to new lows this week. This when the broader market experienced a strong rally! This one might find weak support around $17 and that's why we've placed our profit stop at $17 which should give us a double. It may have further downside to $14, the July 2004 low, but the bulk of the move could be over by $17 and that's where we'll exit.
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 - $32.98 General Motors ** Stop $33.80 **
There was some good news for GM this past week as there was some renewed interest in junk bonds and GM benefited from this. This speculative interest in junk bonds will likely suffer with a turn back down in the broader equity market and GM will probably get hit harder than the others. Price has bounced back up to the 100-dma at $33.23 and this moving average has held price down for over a year now. I see no reason for it to be successful in getting above this average this time. Our stop was at $33.50 but I'm moving it up slightly to $33.80 in case GM manages to close its gap down on March 16th at $33.72.
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.
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
Entry $29.35 (4/04)
CAL - $12.84 Continental Airlines ** Stop $13.50 **
CAL bounced up to the downtrend line from its January high, at $13, and pulled back. The airlines have been helped by the drop in oil prices but CAL looks weak--it's putting in lower highs and looks ready to roll back over. But we have our stop just above in case the airlines in general are able to pull CAL higher.
CAL rose +1.50 on May-3rd 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.
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.
No insurance call due to the low price on the Leap.
Entry $12.00 (03/31)
OSTK $40.56 Overstock.com ** Stop loss $39.00 **
We got close to the $31 profit target but the shorts must have gotten nervous and started covering early. Price bounced up to its downtrend line but once it got above $37.50 it spiked higher and took us out at our stop. I suspect this is going to roll back over, and a different downtrend line drawn from December 29th through the January 27th highs shows resistance might be found at about $41.70. In addition to that resistance, price is currently stalled near its 50-dma at $40.37. We might take another look at this but for now our play is over.
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. As I said, we'll keep an eye on this one if it looks like it's going to roll over again.
September $40 Put QKT-UH @ $5.70
Entry $42.60 (04/04)
Leaps Trader Watch List
XMSR and SIRI have captured the hearts and minds of the investing listener with 100 channels of clear programming. The Ipod and its clones have captured the younger generation and conventional radio is dying. I read an article last week that said CCU, despite its size and diversity, was only growing at a +3% rate and that was in danger. The U.S. has clearly embraced the satellite radio craze and with almost all new cars offering satellite radio as an option it is only a matter of time before Clear Channel begins to shrink rather than grow.
The stock has traded in a range since last September from $30-$35. It appears that range is about to break. While I would like to see one more bounce to something in the $32.50 range I think a breakdown is imminent. I added it to the watch list this week.
I can't afford to add a bunch of new targets given the volatility of the market and the calendar period ahead. We have a good mix of calls/puts and until we take profits on some I am going to refrain from any new targets.
I personally think CME is about to crater big time given the various exchange combinations and new offerings being discussed. I would target something in the $120-150 range but the LEAPS are far too expensive. If you have a big budget you might try some in the money puts rather than leaps.
ADSK is taking off again. We exited that play as a non performer back at $30 and it is pressing $36. I still like the company and I believe the rally will continue but summer is not kind to tech stocks. Try to enter on a pullback.
TIVO is ripe for a takeover. It can't seem to get over $6.50 but is holding over $5. Market share is growing but so is competition. I have heard numbers mentioned in the $10 to $12 range given their brand. You could probably buy some November $5 calls for a buck. Consider it a lottery play.
EBAY is starting to show some life after putting in a bottom at $31. Unfortunately it is considered a tech stock and I think we stand a good chance of another dip. I am going to add it with a breakdown target only and not expect to be triggered until summer.
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.
Current Watch List
CCU - $29.93 Clear Channel Communications
Breakdown Target $28.00 **
Radio is changing with the advent of satellite and conventional AM/FM is fighting an uphill battle.
No insurance call - Stop at $35.00
EBAY - $35.05 EBAY Inc
Breakdown Target $32.00 **
EBAY has finally started finding a bid and $31 appears to be a bottom. If we get another dip over the summer I would be happy with an entry at $32. It appears investors have forgotten that Meg Wittman considered leaving to go to Disney.
Insurance put - OCT $30 PUT XBA-VF currently $1.40
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