Option Investor

Weekly Newsletter, Saturday, 08/27/2005

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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

Ready for Fall

Despite oil hitting another new record at $68 there was little confirmation from the individual stocks. The massive drop in oil at Friday's close from near record levels shows how quickly sentiment can change in what many consider as a bubble market.

Adding to that confusion was some I generated myself by posting incorrect entry triggers on some watch list stocks last weekend. I had so many updates to do it appears I got my fingers crossed. Chesapeake and Arch Coal were incorrect. I am adding Chesapeake this weekend using the Friday price to correct that problem. Arch Coal was not triggered and I will expound on that in the watch list commentary.

As we draw near to the end of summer and the end of the peak driving season the demand for gasoline will ease. Gasoline prices will ease but they never return to "normal". Demand will begin to rise for heating oil, jet fuel and diesel. Refiners will undoubtedly decline after Labor Day but that should be considered an entry opportunity. Once the conversations shift to the shortages/prices of the other distillates they should move back to new highs. Refinery capacity is running at 100% and it makes little difference which product they are producing. There will also be some refinery outages as they switch over to the winter products and formulas.

As I said in the Option Investor wrap I think $68 may be close to a short-term top in oil unless hurricane Katrina does some serious damage in the Gulf. The demand lull will take the pressure off prices until the next story appears. Traders fell $70 is a given but $75 is seeing a lot more skepticism. This is good as it prompts traders to short the highs thinking we are at a top. If those highs are exceeded then the short covering sends it even higher.

We had the normal oil related stories of supply disruptions from fires, breakdowns, terrorists, civil unrest and assorted political stories. Overriding all of them for me was the bid by another Chinese oil company to acquire oil assets. CNPC bid $55 for PetroKazakhstan in a $4.5B acquisition. However, the story does not end there. India's Oil and Natural Gas Corp (ONGC) was evidently the losing bidder and they are weighing a higher bid. China's CNPC has already said they have the option of matching any higher bid. The stock traded up to $55.58 on Thursday in anticipation of ONGC bidding higher or an as yet unnamed third party making a higher bid. It pulled back slightly in Friday's oil sell off but the anticipation is still there.

The key point here really revolves around the comments surrounding the bids. Both India and China said they need to "lockup" reserves well in advance of their actual need. I have mentioned this a lot in the past that it is no longer a game of who sells oil by the barrel on the daily market but who controls the actual reserves and plans on keeping them for themselves. There is no reason to go global shopping for reserves if you are just going to sell them on the open market like everyone else. If there were only 100 gallons of gas left in your town you would not buy them just to resell them to the next guy at a higher price. You would buy them to put into your own car. If it only burns 10 gal a month you would save the rest, NOT RESELL IT. This is where I believe everyone else is missing the boat. It is not just a game between resellers. It is a life or death game of critical commodity acquisition. Oil is the life blood of a nation and those without it ten years fro now are going to be at the mercy of those that have plenty. It will not be a question of price once supplies begin declining but a question of desperation.

Because PKZ is a Canadian firm primarily doing exploration and production in Kazakhstan there would be a limited number of bidders and it is not a national security event for Canada. They said there will be no effort to block the bid.

It is only a matter of time before India or China announce their next acquisition because both of these oil starved countries are well ahead in seeing the future. Whether Peak Oil is one year away, five years or even ten, it is coming and we will see a major change in global hostility.

The game for us is to identify those companies that will either be potential targets or profit substantially from the rise in oil prices.

We were triggered on several breakout events on Monday when oil hit new highs for the first time. The event spiked oil stocks out of their ranges and the instant retracement of the crude price started stocks back on the road to decline. Even the gradual rise back to $68 on Friday was not able to breath life back into many issues. Fear of the weekend and fear of no hurricane damage created a lingering weakness that accelerated into the Friday close. That means we are underwater in some of our new entries after only a week.

Because of the potential instability in oil after Labor Day I am not adding any new watch list items and we will nurse our current positions until a new trend appears. If anything I expect another serious dip in price next week if Katrina turns out to be a weakling. It will be portfolio managers trying to book some profits as August closes.

Check each position for potential put insurance entries.

October Crude Chart - 90 min


Changes in Portfolio

New Plays
CHK $28.11 Chesapeake Energy

Dropped Plays


New Watch List Plays Triggered

Portfolio Listing & Top Picks

New Plays

Most Recent Plays

UPL $41.66 Ultra Petroleum ** Stop loss $38.50 **

Ultra blasted out of the gate on Monday to trigger our entry at $40 and came very close to a new high at $42.50 on Friday after a week of stead gains. Ultra was one of the best performing energy stocks for the week with very little retracement at Friday's close. I looked at an insurance put but UPL has been doing so well I am going with a stop loss instead.

Company info:

Ultra Petroleum Corp. is an oil and gas company engaged in the development, production, operation, exploration and acquisition of oil and gas properties. The Company's operations are focused in the Green River Basin of southwest Wyoming and Bohai Bay, offshore China. During the year ended December 31, 2004, it owns interests in approximately 166,974 gross (92,997 net) acres in Wyoming covering approximately 260 square miles. The Company owns working interests in approximately 241 gross productive wells in this area and is operator of 41.5% of the 241 gross wells. Through Pendaries Petroleum Ltd., it is active in oil and gas exploration and development in Bohai Bay, China. The Company also owns interests in 15,518 gross (14,652 net) acres in Pennsylvania, as well as interest in approximately 720 gross (320 net) acres and interests in three productive wells in Texas.

Jan 2007 $45 LEAP CALL OZH-AI @ $8.40

Alternate short-term entry:
March $45 Call UPL-CI @ $4.40

Entry $40.00(8.22)

MRO - $59.28 Marathon Oil ** Stop loss $57.50 **

Marathon also spiked out of the gate on Monday but unlike UPL drifted lower the rest of he week. It appears to have found light support at $59 with stronger support at $58. I am putting a stop just under that support at $58. No insurance put.

Company Info

Marathon Oil Corporation (Marathon) is engaged in worldwide exploration and production of crude oil and natural gas. It operates through three segments: exploration and production (E&P), which explores for and produces crude oil and natural gas; refining, marketing and transportation (RM&T), which refines, markets and transports crude oil and petroleum products, and integrated gas (IG), which markets and transports natural gas and products manufactured from natural gas, such as liquefied natural gas (LNG) and methanol. The Company's principal operating subsidiaries are Marathon Oil Company and Marathon Ashland Petroleum LLC (MAP). During the year ended December 31, 2004, the Company's worldwide liquid hydrocarbon production averaged 170,000 barrels per day (bpd) and sales of natural gas production, including gas acquired for injection and subsequent resale, averaged 999 million cubic feet per day (mmcfd).

JAN-2008 $65 LEAP Call WXM-AN @ $6.50

Alternate short-term entry:
Jan-06 $65 Call MRO-AM @ $2.90

Entry $61 (8/22)

COP - $61.95 Conoco Phillips ** Stop loss $58.00 **

I was disappointed in the performance of COP. This is my favorite big oil stock with an aggressive reserve acquisition program. Reserves are being replaced faster than they are depleted and that gives COP a bright future. After a very nice run to $67 it fell more than -10% to just over $60 on the prior weeks selling. The rebound faltered and COP has returned to light support at $62. I am putting a wide stop on it because the Oct $60 put is still near $2. I would rather bleed premium than pay $2 for insurance right at support.

Company Info:

ConocoPhillips is an integrated energy company. The Company's business is organized into six operating segments. The Exploration and Production segment primarily explores for, produces and markets crude oil, natural gas, and natural gas liquids on a worldwide basis. The Midstream segment gathers and processes natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids. The Refining and Marketing segment purchases, refines, markets and transports crude oil and petroleum products. The LUKOIL Investment segment consists of the Company's equity investment in LUKOIL, an international, integrated oil and gas company. The Chemicals segment manufactures and markets petrochemicals and plastics on a worldwide basis. The Emerging Businesses segment encompasses the development of new businesses, including new technologies related to natural gas conversion into clean fuels and related products, technology solutions, power generation and emerging technologies.

JAN-2007 $65 LEAP CALL OJP-AM @ $7.50

Alternate short-term entry:
Jan-06 $65 Call COP-AM @ $4.40

Entry $63.50 (8/22)

CHK - $28.11 Chesapeake Energy ** Stop loss $25.75 **

Chesapeake has a very nice chart like UPL. All uphill and very little give back on Friday. CHK is primarily a gas company and will continue to profit from the growing demand and shortage of natural gas. It should be insulated somewhat from the price of oil as the September fluctuations appear. However, it will profit from any rise in the price. I am setting the stop under the August low in lieu of an insurance put.

I listed the trigger price wrong in last weeks update so we were not triggered. This is a new entry with prices as of Sunday.

Company Info

Chesapeake Energy Corporation is an oil and natural gas exploration and production company engaged in the acquisition, exploration and development of properties for the production of crude oil and natural gas from underground reservoirs and the marketing of natural gas and oil for other working interest owners in properties that it operates. The Company's properties are located in Oklahoma, Texas, Arkansas, Louisiana, Kansas, Montana, Colorado, North Dakota and New Mexico. The proved oil and natural gas reserves as of December 31, 2004 were approximately 4.9 trillion cubic feet of gas equivalent (tcfe). At December 31, 2004, approximately 89% of the Company's proved reserves (by volume) were natural gas, and approximately 70% of its proved oil and natural gas reserves were located in the primary operating area, the Mid-Continent region of the United States, which includes Oklahoma, western Arkansas, southwestern Kansas and the Texas Panhandle.

JAN 2007 $30 LEAP CALL VEC-AF @ 4.90

Alternate short-term entry:
Jan-06 $30 Call CHK-AE @ $2.25

Entry $28.11 (8/28)

VLO - $89.34 Valero Energy ** No stop **

Valero is my favorite refiner, the largest in the U.S. and the only one with a high capacity for sour Saudi Crude. They will constantly have margins 3-4 times other refiners who can only process light sweet crude. They took a hit this week as the end of driving season approaches and they may continue to show weakness until the next crisis appears. Fear not they will continue to blow away earnings and this will attract new buyers.

VLO appears to respect the 30-day average and that would be a good spot for a new entry if you did not buy on last weeks trigger. Also, due to the prices of the options I would recommend the shorter option rather than the LEAP. You get what you pay for but I hate to pay over $10 for a LEAP that is $10 out of the money. VLO tends to move fast and far when it moves. Therefore I am putting an insurance put on this position.

Company info:

Valero Energy Corporation (Valero) owns and operates 15 refineries having a combined throughput capacity, including crude oil and other feedstocks, of approximately 2.5 million barrels per day. Valero produces environmentally clean refined products, such as reformulated gasoline (RFG), gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen). It also produces conventional gasolines, distillates, jet fuel, asphalt and petrochemicals. Valero markets branded and unbranded refined products on a wholesale basis in the United States and Canada through a bulk and rack marketing network. It sells refined products through a network of more than 4,700 retail and wholesale branded outlets in the United States, Canada and Aruba. Valero's retail operations include approximately 1,500 company-operated sites that sell transportation fuels and convenience store merchandise.

JAN 2007 $100 LEAP CALL VHB-AT @ $12.10

Alternate short-term entry:
Mar-06 $100 Call VLO-CT @ $6.40

Insurance put: October $80 Put VLO-VP @ $1.50

Entry $89 (8/22)

XLE - $47.97 Energy SPDR ** Stop Loss $46.50 **

The XLE traded sideways in a $1 range all week with weakness in some components offset by strength in others. When it goes directional on broad sector strength it is a steady mover with very little risk. This is the index fund for energy traders. Options are cheap and insurance is cheaper if you want it. Because of the low price of entry I am not suggesting an insurance put.

SPDR Description:

The XLE SPDR is composed of 27 energy stocks and represents about 9% of the SPX. This is the 9% 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.

List of XLE components: XLE List

JAN 2007 $55 LEAP CALL OJW-AC @ $3.50

Alternate short-term entry:
Jan-06 $50 Call XBT-AX @ $2.45

Entry $49 (8/22)

MEE - $46.88 Massey Energy ** Stop Loss $44.00 **

Massey sprinted out of the gate on Monday but declined slowly the rest of the week. Massey is a favorite of Boone Pickens and one of the stocks he recommends. They have a high demand low sulphur coal with reserves of 3.2 billion tons. Since I placed this on the watch list I saw an analyst downgrade it. While I don't agree with his premise I want to be cautious and I am placing a tight stop on it. I value Boone Pickens opinion more than a part time energy analyst.

Company info:

Massey Energy Company (Massey) produces, processes and sells bituminous coal of steam and metallurgical grades of a low-sulfur content through its 22 processing and shipping centers, called resource groups, many of which receive coal from multiple coal mines. Massey operates 34 underground mines (four of which employ both room and pillar and longwall mining) and 15 surface mines (with seven highwall miners in operation) in West Virginia, Kentucky, and Virginia. Its steam coal is purchased by utilities and industrial clients as fuel for power plants. Its metallurgical coal is used to make coke for use in the manufacture of steel.

JAN 2007 $50 LEAP CALL VHK-AJ @ $9.00

Alternate short-term entry:
Jan-06 $55 Call MEE-AK @ $2.95

Entry $49 (8/22)

Play Updates

Existing Plays

TLM $45.74 Talisman Energy ** Stop $43.00 **

Talisman finished the week about where it started despite a strong drop at Friday's close. TLM was strong all week and held just $1 under its recent highs. The stop is just under the August lows and would represent about a $1 loss if hit.

Company info:

Talisman Energy Inc. (Talisman) is an independent international upstream oil and gas company whose main business activities include exploration, development, production, transporting and marketing of crude oil, natural gas and natural gas liquids. The Company's operations, during the year ended December 31, 2004, were conducted principally in four geographic segments: North America, the North Sea, Southeast Asia and Algeria. The Trinidad Angostura project began production in January 2005. Exploration is being advanced in other areas outside the principal geographic segments, including Alaska, Colombia, Qatar and Peru. During 2004, total production averaged 438 million barrels of oil equivalent per day (mboe/d) and the Company exited the year producing 452 mboe/d in December. In 2004, the Company drilled 641 successful wells.

Jan 2006 $50 CALL TLM-AJ @ $2.10
(no leaps)

No insurance put due to cheap option

Entry (8/17) $45.00

HP - $55.63 Helmerich Payne ** Stop Loss $52.50 **

HP posted a nice week long rebound only to give back a little ground on Friday. No real weakness here and drillers will always be in high demand. I raised the stop to just under the August low and about -$2 under our entry.

Company Info:

Helmerich & Payne, Inc. is primarily engaged in contract drilling of oil and gas wells for others. It is also engaged in the ownership, development and operation of commercial real estate. The Company is organized into two separate operating entities: contract drilling and real estate. The Company's contract drilling business is composed of three business segments: United States land drilling, United States offshore platform drilling and international drilling. The Company's United States land drilling is conducted primarily in Oklahoma, Texas, Wyoming, Colorado, and Louisiana, and offshore from platforms in the Gulf of Mexico and California. The Company also operated in eight international locations during the fiscal year ended September 30, 2004: Venezuela, Ecuador, Colombia, Argentina, Bolivia, Equatorial Guinea, Chad and Hungary. In addition, the Company is providing drilling consulting services for one customer in Russia. Its real estate investments are located in Tulsa, Oklahoma.

MAR 2006 $60 CALL HP-CL @ $3.20
(no leaps)

No insurance due to cheap option

Entry (8/17) $54.00

NOV - $58.30 National Oilwell Varco ** Stop loss $55.00 **

NOV flat lined all week but that is not a bad thing given the loss in other stalwarts like COP. Currently holding just -$3 under its all time high I still have high hopes for a continued rebound.

This company is very strong with revenue doubling in their most recent earnings report on Aug-5th. Their guidance was very strong for 2H-2005 and beyond. The company merged with Varco back in March and the synergies are very good. After a period of post merger consolidation over the spring the trend has picked up substantially.

Company info:

National-Oilwell Varco Inc., formerly National-Oilwell, Inc. designs, manufactures and sells systems, components and products used in oil and gas drilling and production, as well as distributes products and provides services to the exploration and production segment of the oil and gas industry. The Company's Products and Technology segment designs and manufactures complete land drilling and work over rigs, as well as drilling-related systems on offshore rigs. Non-capital revenue sources within its Products and Technology segment include drilling motors and specialized down hole tools that are sold or rented, spare parts and service on the large installed base of its equipment, expendable parts for mud pumps and other equipment and smaller down hole, progressive cavity and transfer pumps. Company's Distribution Services segment provides maintenance, repair and operating supplies and spare parts to drill site and production locations throughout North America and to offshore contractors.

FEB 2006 $60 CALL NOV-BL @ $6.00
(no leaps)

Entry $59.50 (8/10)

Leaps Trader Watch List

In just one week we built the portfolio back to 10 positions. While I wish I could say they were all great entries I can't. The oil spike on Sunday night sent all stocks surging higher at the open and for some that was the high for the week. There is nothing orderly about trading oil given the various global events that can cause problems.

I removed SWN and ACI and added Peabody Energy (BTU) and Encana (ECA). I do not plan on adding any more energy plays until after the early September refinery switch away from gasoline. I want to see a new trend develop before putting any more money at risk in the sector. We were planning on exiting our long-term oil plays in September but the market beat us to the exit.

Arch Coal was not triggered last week due to an error on my part. After doing some research on the different coal companies I decided to replace ACI with BTU.

I still expect higher highs on oil before year-end but it may not start until the end of September. We have a full portfolio and can afford to wait.

Good luck!

Dropped Entries
SWN Declining performance, analyst downgrade
ACI Replacing with Peabody    

New Watch List Entries
Peabody Energy
ECA Encana Corp

Current Watch List

ECA - $44.76 Encana

** Breakdown Target $43.00 **
** Breakout Target $46.00 **

EnCana Corporation is an independent crude oil and natural gas exploration and production company. Its key landholdings are in western Canada, the United States Rocky Mountains, Ecuador, the United Kingdom central North Sea, offshore Canada's East Coast and the Gulf of Mexico. EnCana explores for, produces and markets natural gas, crude oil and natural gas liquids (NGLs) in Canada and the United States. EnCana is also engaged in exploration and production activities internationally including production from Ecuador and the United Kingdom central North Sea. EnCana has interests in midstream operations and assets, including natural gas storage, NGLs gathering and processing facilities, power plants and pipelines.

Breakdown Target
Alternate short-term entry: Jan-06 $45 Call ECA-AI

Breakout Target
Alternate short-term entry: Jan-06 $50 Call ECA-AJ


BTU - $64.72 Peabody Energy

** Breakdown Target $56.00 **
** Breakout Target $67.25 **

Peabody Energy Corporation (Peabody) is a private-sector coal company in the world. During the year ended December 31, 2004, the Company sold 227.2 million tons of coal. It sells coal to over 300 electricity generating and industrial plants in 16 countries. The Company owns, through its subsidiaries, majority interests in 32 coal operations located throughout all the United States coal producing regions and in Australia. Most of the production in the western United States is low-sulfur coal from the Powder River Basin. In the West, it owns and operates mines in Arizona, Colorado, New Mexico and Wyoming. In the East, it owns and operates mines in Illinois, Indiana, Kentucky and West Virginia. The Company owns four mines in Queensland, Australia. Most of the Australian production is low-sulfur, metallurgical coal. In addition to the mining operations, the Company markets, brokers and trades coal.

Breakdown Target
(no leaps)

Breakout Target
(no leaps)


CNX - $63.92 CONSOL Energy

** Breakdown Target $60.00 **
** Breakout Target $66.00 **

CONSOL Energy Inc. is a multi-fuel energy producer and energy services provider that primarily serves the electric power generation industry in the United States. The Company has two principal business units, Coal and Gas. The principal activities of the Coal unit are mining, preparation and marketing of steam coal, sold primarily to power generators, and metallurgical coal, sold to steel and coke producers. As of December 31, 2004, CONSOL Energy produced high-British thermal unit (Btu) bituminous coal from 17 mining complexes in the United States and Australia. The principal activity of the Gas unit is to produce pipeline quality methane gas for sale primarily to gas wholesalers. The Company provides energy services, including terminal services, industrial supply services and coal waste disposal services. It is developing its land assets that it previously used primarily to support its coal operations.

Breakdown Target
Alternate short-term entry: Jan-06 $65 Call CNX-AM

Breakout Target
Alternate short-term entry: Jan-06 $70 Call CNX-AN


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