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Weekly Newsletter, Sunday, 05/29/2005

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Table of Contents

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

Leaps Trader Commentary

Oil and Equities Push Higher

Oil got a nice bounce this week from Monday's low of $48.05 (July contract) to a high of $52.00 on Friday. At the same time the broader equity market continued to climb slightly higher for the week as well. The fact that oil climbed back above $50 didn't seem to make equity bulls particularly nervous and that helped the oil stocks which saw a very nice rebound this week. The oil index (OIX.X) has rallied from its 428.62 low on May 16th to close at 462.07 on Friday, for a 7.8% rally in two weeks. On Friday it also broke its downtrend line from the March high and closed slightly above its 50-dma. This is clearly bullish action and if next week shows a retest of the broken downtrend line, currently at about 454, that holds, I would say there's an excellent chance we'll see the rally continue higher. Oil is also threatening to break its downtrend from the April high but it doesn't look quite as bullish yet as the index. The charts are looking a little extended at the moment so a pullback is expected soon, including in the broader market, and that pullback should give us some clues as to whether or not we should go ahead an close out our insurance put options.

These insurance puts will continue to protect us if we get more downside and with the broader market looking especially vulnerable to a pullback, it's too early to cash in on the insurance puts. We'd like to take profits on the puts so as to decrease our cost in the LEAPs but only when it has become more certain that the downtrend has been broken. The US dollar continued its rally this week before pulling back on Friday but this didn't negatively affect the price of oil whereas previous rallies in the dollar had depressed commodities in general, including oil Commodities also rallied this week so it was just a bullish week all around. Something will give next week and that's what we'll wait for instead of making decisions on our LEAPs portfolio this weekend.

At the beginning of last week I had thought the broader equity market looked tired and was ready for a pullback. But the market chugged a little higher after a small pullback. If you look at the DOW and SPX and draw an uptrend line from March 2003 through their October 2004 lows, you'll see that price broke that uptrend line in April and have now come back up to test the underside of that uptrend line. After last week's test of the trendline, we have another higher test this week but with negative divergences on the charts. We either have a perfect short entry at that line (support now turned resistance), or the Bulls are prepared for an assault on the Bears and will breach that line of defense causing the Bears to panic which will create a strong short covering rally. How this plays out will have an effect on our portfolio.

The only change to our portfolio from last week was the drop of OSTK since it rallied up and hit our stop the previous week. I still view this stock bearishly and price did drop back down below our stop level of $39 but it could find support from its 20 and 30-dma's near $37.40. We'll watch this one a little longer.
 


Changes in Portfolio

New Plays
None

Dropped Plays
None

New Watch List Plays Triggered
None

New Plays

Most Recent Plays

None.

Play Updates

Existing Plays

CHK - $20.29 Chesapeake Energy ** No Stop **

Once again the 200-dma acted as a strong support level, something it's been since July 2002. After dropping to $17.74 on May 16th, CHK has climbed over $2.50. It is now approaching its 50-dma at $20.40 and is probably due a pullback, especially in light of the opening discussion on the broader market. We'll leave the insurance puts in place until we get a clearer buy signal but so far price action looks very encouraging for our LEAP call.

Company Info

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.


2007 $20 LEAP Call VEC-AD @ $4.00

Insurance put: July $17.50 CHK-SW @ 90 cents


Entry $19.00 (05/13)
CHK Chart

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FNM - $60.74 Fannie Mae ** No Stop **

Along with the broader market FNM got a further boost this past week. There was some good news in the housing numbers and with long term rates remaining depressed there was some positive press about the mortgage industry. The price level resistance at $57 was broken, briefly tested and then price took off from there. Fortunately we have the insurance call position and we'll watch the next level of resistance at about $63, the low in October 2004. Just above that level, and dropping, is the 50-dma at $64.74. Our June 55 call will be in fine shape if those levels are reached and we'll consider taking profits at that point so as to reduce the cost of our LEAP put.

Company Info

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)
FNM Chart


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APC - $76.09 Anadarko Petroleum ** No Stop **

Like CHK above, APC came down for a perfect test of its 200-dma. On Friday price broke above the last high of $75.00 on May 6th so the succession of lower highs has now been broken. If we get a broader market pullback and APC manages a successful test of its 100-dma at $71.82, and climbing, that will be a strong indication that we will have successfully caught the pullback.


Company Info

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

Entry $70.50 (5/04)
APC Chart


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COP - $107.55 Conoco Phillips ** No Stop **

COP is another example of the string of lower highs being broken--on Friday price climbed above its last high of $106.74 on May 6th. This is a bullish development and now a pullback that stays above its 100-dma, currently at $101.87, will show that we got an excellent entry at $98.

Company Info

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 @ $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)
COP Chart


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OXY - $73.52 Occidental Petroleum ** No Stop **

OXY continues to outperform its peer. It is has been in a much shallower pullback since March and consequently is much closer to breaking to a new all-time high above $74.95. It will likely pull back with the others but I would be surprised to see it drop back to its 100-dma, currently at $66.98. This one looks ready to go.

Company Info

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.
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 @ $1.40

Entry $68.00 (4/19)
OXY Chart


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XOM - $56.80 Exxon Mobil ** No Stop **

XOM doesn't look quite as strong as the others although it too shows a bullish pattern by the pattern of the pullback--it looks very much like a bull flag after a strong rally. Finding support at its 200-dma is bullish. After a brief dip below its long term uptrend line and the climb back above it is also bullish. Now it looks like it may do battle with its 100-dma at $57.05 and then right above that the top of its flag pattern at about $57.40. We'll likely see a pullback from this level but I expect to see it stay above its uptrend line near $54.50. We'll watch the next pullback in these stocks and make a decision about covering the insurance put.

Company Info

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.


2007 $60 LEAP Call ODU-AL @ $6.70

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


Entry $58.00 (4/19)
XOM Chart


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XLE - $42.00 Energy SPDR ** No Stop **

XLE looks like the other strong ones in that it too broke its string of lower highs by breaking above its May 6th high of $41.77. If we get a pullback that successfully tests its 100-dma, currently at $40.63, it could be off to the races for this group.

Company Info

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)
XLE Chart


XLE Components

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VLO - $70.49
Valero Energy ** No Stop **

After breaking below price level support at $65 VLO has rallied back above it and in so doing has also bounced back above its 100-dma. It has also taken out the previous high of $69.85 on May 10th. The combination of the $65 level and the 100-dma at the same level should support any further pullback. If that level were to be broken during another pullback, we could get a drop to the 200-dma (unlikely in my opinion) which is where we would take profit on the insurance put.

Company Info

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.


2007 $75 LEAP Call VHB-AO @ $14.10

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

Entry $68.00 (4/15)
VLO Chart


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CVX - $54.58 Chevron Texaco ** No stop **

CVX got another bounce off price level support around $50.50 and closed on Friday back above its 200-dma and above its downtrend line from February. It's got a little more work to do to get above it 100-dma at $55.58 but it did break above its last high of $54.36 which was its gap open high on May 6th. We could see a pullback to retest its downtrend line but price action looks bullish here. The bearish picture would be a drop back down below $50 since it would then look like a H&S top. After another failure of the 200-dma in that case, we would have to think hard about holding onto this position. Until then, it's looking up from here.

Company Info

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.


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)
Chevron Chart


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TOO - $20.14 TOO Inc ** Stop Loss $22.50 **

After a sharp drop it appears TOO has been consolidating in a shallow climb. It looks like a bear flag and should proceed lower once the correction is finished. In fact it could be soon--the 30-min chart (not shown here) shows price is once again up to the 130-pma, a moving average that has consistently held price down. It could bounce a little higher but I don't think it will even reach the opening price level of $21.00 when it gapped down on May 17th. Assuming it will roll over again, there could be 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.

Company Info

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)
TOO Chart


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GM - $31.83 General Motors ** Stop $33.80 **

I'm glad we moved our stop up last week from $33.50 to $33.80 to keep it away from an attempt to close the March 16th gap. On Monday GM got up to $33.54 and would have tagged our stop by $0.04. We still don't have a lot of breathing room on this trade but at least we have the 100-dma at $32.82, and dropping, between us and our stop now. It's like standing behind our strong friend and telling him to go beat up on price now. This moving average has held price down for over a year now and let's hope it continues to do so for the sake of our play. Price now needs to drop back below $30.25 to make me breathe easier about this play. If we get a broader market pullback next week, this one should be one of the leaders to the downside.

Company Info

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

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

Entry $29.35 (4/04)
GM Chart - Daily


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CAL - $13.19 Continental Airlines ** Stop $13.50 **

CAL looks ready to roll over at any moment. The rise off its January low looks like a large bear flag. But airlines got a lift this week, especially on Thursday and CAL participated. The fact that it broke back above recent highs and its downtrend line from January makes it look like this will press a little higher. But if the broader market pulls back early in the weak, then our stop at $13.50 will be safe from being hit. Price now needs to get back below $12.22 in order to get the next decline going.

Company Info

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.


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 an insurance
call would cost today.

Entry $12.00 (03/31)
CAL Chart

 

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