Option Investor

Weekly Newsletter, Saturday, 11/26/2005

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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

Double Cold, Double Good

Hold on to your sled boys and girls. The cold front that started in the Midwest early in the week ended with a bang in the Northeast and dumped snow and cold over much of the nation. Following on its heels is another large front heading south over Montana and scheduled to blanket the Rockies and the Midwest with snow before moving toward the Northeast in a repeat of this weeks weather.

For investors in gas stocks this should be the perfect storm to provide a one-two punch to supplies and accelerate the draw down of supplies in storage. The January natural gas contract has resisted firmly the attempt by sellers to move it below $11.50. With the first draw down in supplies last week since the hurricane volatility it appears the winter trend is about to begin. Shorts hoping for a warmer winter and a sharp drop should that $11.50 level break are probably grabbing for a warm security blanket this weekend. It could get rocky in the days ahead and $13 is the next resistance level.

Oil continues to hover just under resistance at $59 and appears waiting for gas to explode before moving higher. Over the summer gas rose in association with oil and now it is oils turn ride the coattails of gas.

While all of this could be wishful thinking we have seen energy stocks inch up over the last week and some are nearing breakout levels again. While the talking heads on TV fixate on the minute by minute gyrations of crude many of the energy stocks are in a stealth rally.

We did not lose any positions this week and saw gains across the board. Those gains came in the form of reduced losses on several positions after three months of energy declines had put us under water on most. Our time is coming and I am hoping for 2-3 weeks of gains before we lighten the load in January.

We did have a new play triggered from the skinny watch list and that gave us something to do while we wait for colder weather.

I mentioned in the Option Investor commentary that Thanksgiving 2005 was the target date for Peak Oil by Kenneth Deffeyes. He used the same methodology as Hubbert did in correctly predicting in 1956 the peak in U.S. production in 1970. Of the various peak oil commentators I follow the general consensus is still fall of 2007 for the beginning if the irreversible decline. We should have considerable volatility before that date as pressures at the top squeeze demand and delay the eventual decline. As sure as night follows day the decline is coming only the hour is yet unknown.

As energy investors we should see a minimum of four more price cycles before fall of 2007. Maybe as much as six. It will be our responsibility to buy the dips on each cycle as each low should be higher than the last. This is the perfect time to be pondering the future and positioning ourselves for maximum profits.

As we exit our current positions in January I am going to begin adding in some alternative energy plays such as solar and atomic energy. The next few weeks could be boring but the next few years could easily double and triple your portfolio even if we miss a few along the way. Be patient and prosper.

Natural Gas Chart - Daily

Crude Oil futures Chart - Daily

Changes in Portfolio

New Plays


Dropped Plays


New Watch List Plays Triggered
HW $35.82 Headwaters

Portfolio Listing & Top Picks

New Plays

Most Recent Plays

HW - $34.57 - Headwaters ** No Stop **

HW moved through the $35.50 trigger on Tuesday but the pace higher slowed as volume slowed in the market.

Headwaters (HW) has a compound annual growth rate of more than +120% mainly because it deals with the ash left over from burned coal. Coal generates a lot of ash and it is a problem the electric generating plants have to deal with when these cold fronts really suck up their coal supplies. Headwaters has three separate businesses from that ash. They have a business that buys and sells it for various purposes. Second they have produced a bonding agent to that makes it easy to transport without blowing out of the rail cars. They sell this to others for profit. Third they have a patented process for converting this ash into a synthetic fuel, which is licensed to plants that actually do the conversion.

They also make building materials and a cement substitute that uses this ash to make concrete more durable. Considering the thousands of tons of ash generated each week this appears to be a gold mine for Headwaters. When electric plants fight the tons of daily ash Headwaters is there to help and converts that ash back to dollars. This sounds too good to be true and I think that was the real problem with the decline from $46 in August to the $30 level in October. The ramp from IPO in April from $30 to $46 and decline back to $30 is complete. Those that got in on the good IPO story took their profits as energy prices declined. Now may be the time to jump back on the coal train with Headwaters rather than Peabody.

Company Info:

Headwaters Incorporated is a diversified company providing products, technologies and services to the energy, construction and home improvement industries. Headwaters conduct its business primarily through four business units, including Headwaters Resources, Headwaters Technology Innovation Group (HTI), Headwaters Construction Materials and Headwaters Technology Innovation Group. In September 2004, the Company acquired Tapco Holdings Inc., a manufacturer of building products and professional tools used in residential remodeling and construction. In June 2004, the Company acquired Eldorado Stone, LLC, a manufacturer of architectural manufactured stone based in San Marcos, California. Eldorado Stone is being purchased from Graham Partners, a middle-market private equity firm. Eldorado Stone will be integrated into Headwaters' coal-based construction materials operations.

2007 $40 LEAP Call ZPP-AH @ $4.30

Insurance Put:
Enter Feb $30 Put HW-NF if HW trades below $33

Entry $35.50 (11/22)


Play Updates

Existing Plays

BP - $67.83 - BP Plc. ** No Stop **

BP continues to climb and is approaching resistance at $69. A strong oil day could go a long way on breaking that resistance.

BP is a very strong U.S. producer although many people have never heard of them. Prudential started them at overweight and they are rending up off their lows. Options are cheap relative to some of the highly volatile favorites.

Company Info:

BP p.l.c. is an oil company trying to remake itself into an energy company. The operating business segments were Exploration and Production; Refining and Marketing; Petrochemicals, and Gas, Power and Renewables. Exploration and Production's activities include oil and natural gas exploration and field development and production, together with pipeline transportation and natural gas processing. The activities of Refining and Marketing include oil supply and trading, as well as refining and marketing. The Petrochemicals segment ceased to operate separately as of January 1, 2005. Gas, Power and Renewables activities include marketing and trading of natural gas, natural gas liquids , new market development and liquefied natural gas (LNG), and solar and renewables. The Company formed the TNK-BP joint venture between the Company and the Alfa Group and Access-Renova (ARR). In addition, it plans to incorporate AAR's 50% interest in OAO Slavneft, a Russian oil company, into TNK-BP.

Buy 2007 $70 LEAP Call VAO-AN currently $5.20

Put Insurance: April $60 Put BP-PL currently $1.30
Buy the insurance only if BP trades at $64.

Entry $66.43 (11/20)

VLO - $101.17 Valero ** Stop loss $96 **

Exit target $108

Valero continues to be rather dormant compared to the days after the hurricanes. With gasoline prices falling the crack spreads are compressing but once heating oil inventories start to fall they should increase. I would like to see a strong bounce in oil to push VLO to $108 before the split. After the split I want to go long on some leaps for the next cycle but we have plenty of time to pick an entry.

Valero will split 2:1 on Dec-16th. We will want to exit before the split.

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.

January $110 Call VLO-AB @ $5.50

LEAPS are far too expensive and I would expect to be out of the trade by Christmas at the latest.

Exit target $108

Entry $100 (11/09)

CHK - $29.40 Chesapeake Energy ** No Stop **

CHK continues to remain dormant just under $30 as we await the winter gas demand. CHK is also suffering from a continuing acquisition program. They are actively acquiring reserves, which will be very positive for the future but analysts wonder at what cost. CHK tries to pay for its acquisitions out of revenue from the acquired reserves by hedging them for several years in advance. This way there is no large debt service to choke them. With several acquisitions pending closure just ahead investors seem to have taken a wait and see attitude. We are protected so no problem on this end except boredom.

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.

2007 $35 LEAP VEC-AG @ $4.00

Insurance Put:
April $25 CHK-PE when CHK traded at $28 on 11/07 @ $2.30

Entry $29 (11/04)

UPL - $54.93 Ultra Petroleum ** Stop loss $50 **

UPL gain nearly +$3 for the week despite closing more than $1 off its highs. UPL has risen to test resistance at $56 and a breakout here could really get things moving. UPL was our best performer last week. There are rumors that China is going to make an offer on the Bohai Bay development off the coast of China. They should sell it if China offers since they would be unprotected from aggression when the oil wars start.

I cancelled the put insurance entry and raised the stop to $50.

Headlines from their earnings on Oct-26th:
Achieves record earnings of $60.9 million, up 118 percent from the same quarter in 2004.
Accomplishes record cash flow of $108.3 million, up 110 percent from the same period in 2004.
Attains record production of 18.7 Bcfe, up 44 percent over third quarter 2004 levels.
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.

MARCH $60 Call UPL-CL @ $5.20

Insurance Put: Dec $45 Put UPL-XI (cancelled not triggered)

Entry $55 (11/02)

STR - $78.09 Questar Corp ** Stop Loss $74 **

Questar continues to hold over its 100-day average and like CHK and UPL any gains will depend on natural gas demand. Questar is finally showing life and rebounded on Friday to its two-week resistance at $78. A drop in gas reserves should push it back over $80.

STR traded -3 cents below $75 on Monday and we were triggered on the Put insurance @ 80 cents. It only has three weeks to run but it was cheap. Personally I would not have entered on the -3 cent spike under $75 but rules are rules.

Company Info:

Questar Corporation (Questar) is a natural gas focused energy company with three principal lines of business gas and oil exploration and production, interstate gas transmission, and retail gas distribution. Questar conducts most of its operations through its subsidiaries Questar Market Resources (Market Resources), Questar Pipeline Company and Questar Gas Company (Questar Gas). Market Resources is a sub-holding company that owns Questar Exploration and Production Company (Questar E&P), Wexpro Company (Wexpro), Questar Gas Management Company (Gas Management) and Questar Energy Trading Company (Energy Trading). Questar Pipeline provides interstate natural gas transmission, storage and gas processing and treating services. Questar Gas conducts retail natural gas distribution.

April $85 Call STR-DQ @ $5.60

Insurance Put
December $70 Put STR-XN @ 80 cents, 11/21

Entry $78.76 (10/31)

COP - $64.00 Conoco Phillips ** Stop Loss $57 **

Conoco is struggling with resistance at $65 and is dependent on a bounce in oil prices to move higher. They are still using their cash to acquire assets with the acquisition last week of a 275,000 bbl refinery in Germany. The 200-day average at $59.12 is still our support cushion.

COP is the most aggressive big oil in attempting to acquire reserves. Their exploration budget for 2006 increased by +127%.

Earnings were Oct-27th

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.

2007 $70 LEAP Call OJP-AN @ $6.40

Insurance Put: Cancelled - no entry

Entry $63.25 (10/31)

UNH - $60.16 Unitedhealth Group ** Stop Loss $57 **

UNH is struggling with $61 after trading higher intraday on Fri/Mon. After several weeks of decent gains UNH may be falling victim to sector rotation and to worries about a bird flu pandemic. Several analysts reports last week suggested that healthcare companies are not equipped to handle the expenses associated to a potential breakout and millions of flu cases. I considered exiting it this week but with no human flu on the horizon investors could decide that earnings are safe for the next few quarters.

Play Reasoning:

UnitedHealth is the leader in the managed heathcare sector. Earnings are soaring, +31% in Q3 to $2.43 billion and the outlook is only up. With health care costs rising more and more companies will turn to UNH to lessen their benefit expenses. We are also expecting a seasonal bounce now that October is behind us. There were two strong sell cycles in October as funds took profits from a long period of gains. Historically health care companies have done very well over the next three months as funds look for safe havens for year-end cash. UNH gained +37% from the October lows for the same period in 2004. Buyers appear on every dip to the 100-day average currently at $53.

Company Info:

UnitedHealth Group Incorporated is a diversified health and well-being company, serving approximately 55 million Americans. The Company provides individuals with access to healthcare services and resources through more than 460,000 physicians and other care providers, and 4,200 hospitals across the United States. It manages approximately $60 billion in aggregate annual healthcare spending on behalf of more than 250,000 employer-customers and the consumers it serves. The Company conducts its business primarily through four operating divisions: Uniprise, Health Care Services, Specialized Care Services and Ingenix. On July 29, 2004, the Health Care Services business segment acquired Oxford Health Plans, Inc. (Oxford). Oxford provides healthcare and benefit services for individuals and employers, principally in New York City, northern New Jersey and southern Connecticut.

2007 $60 LEAP Call VUH-AL @ $6.40

March $50 Put UHB-OJ

Entry $56.75 (10/31)

Leaps Trader Watch List

SUN continues to move higher and farther away from our trigger point. I am removing it this week but for those willing to take the risk a breakout over $80 could be bought with a tight trailing stop.

Since we already have seven energy stocks in the portfolio I am not going to add any to the list this weekend. We have waited patiently for the rebound to begin and now we need to just capture our profits when they appear.

The drillers have taken off in the last four days and entries I was considering last weekend no longer are appropriate. I think we are seeing speculation on the cold front and while the trader part of me wants to keep adding positions I don't believe it is a wise move today.

Winter demand will be peaking just as the year end rolls around and funds will be dumping energy stocks and taking profits in early January. My outlook is for a ramp into Christmas and then a plateau where we should exit. This short term time frame is not worth taking new risks by adding new positions.

In the first week of January I am going to add some shorts but until then I simply don't see any long targets worth pursuing.

Be patient. Our time will come. If you need something to trade buy AHC on a breakout over $133.

Dropped Entries


New Watch List Entries


Current Watch List



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