Option Investor

Weekly Newsletter, Saturday, 12/03/2005

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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

Finally, Winter Arrives With A Bang

Winter arrived with a frosty bang and natural gas demand soared as well as gas prices. Natural gas rose +24% from Monday's low to close at $13.95 on Friday. Thursday's storage levels fell by -49 bcf indicating usage for the week at well over 100bcf. After winters four week delayed start the cold is settling in over most parts of the country and it appears it is here to stay.

The weather scale known as heating degree days is -20% below average for this time of the year. In general terms that means days where the average temperature was less than 65. For every degree under the 65 average it requires additional units of energy to keep living spaces warm. If the average temperature was 60 then it is said to be a 5 heating degree day. The scale allows energy forecasters to predict energy usage. Based on the weather forecast for next week there will be a lot of places in the U.S. where 65 degrees will be very wishful thinking.

The spike in gas prices produced a corresponding spike in crude with a close slightly over resistance at $59. This is encouraging but it is far from exciting. I related an historical fact in the option Investor commentary this weekend and will repeat a portion of it here. Historically when large institutional traders are long oil on Dec-1st by more than 40 million bbls there is a significant energy rally over the next 90 days. On Dec-1st those traders were long over 61 mb and very close to an historic high since the contract began trading. This should mean a good chance of a continued rally but it will also mean a substantial crash when it is over. As other traders climb on the energy train in December it will increase the number of long positions and those positions will need to be reduced in January. Typically positions are accumulated 90 days ahead of demand and exited once the demand cycle peaks. Despite the potential for cold weather in Feb/Mar I suspect January is the exit point for traders. This is fine since we have been planning on exiting in late December or early January for several months now. I personally believe that mutual funds are long energy stocks now ahead of winter and will take profits in January ahead of a potentially rocky stock market year.

The end of week energy rally did not come in time for Valero and Questar. Both were hammered on the Monday massacre and were stopped out. Valero went on to rebound to a new three week high on Thursday without us. While Valero is the volatility queen, second only to AHC, both took a backseat to UNH for the week. UNH had been declining daily for the entire prior week after setting a historic high at $61.65 on Nov-18th. There was definitely somebody sitting on the ask and the stock was pressured all week. On Monday there was some news in the sector about future medical expenses and sitting on the ask became past tense and UNH was dumped hard all day to close at $58.43. On Tuesday UBS issued a buy rating on UNH and the short squeeze was on. UNH closed at the high of the day on Friday and a new historic high at $62. It may not sound like much to have a $4 weekly range given the moves in energy stocks last summer but for UNH it was dramatic.

Real volatility of course looks like a chart from AHC. In the watch list last week I suggested for excitement to buy AHC on a break over $133 after it closed the week near $132. Some of us have been trading it for the last month with buys at $122 and sells over $130. That trend appeared to be about to end with an upside breakout over $133 but looks can be deceiving. AHC crashed on Monday to touch $120 on Tuesday's open only to rebound to over $127 on Thursday. Never a dull moment and the range bound trend appears to be alive and well.

BP and Shell signed their transitional agreements with Venezuela last week as the next step in losing their assets in that country. Venezuela decided last year that 15 oil companies operating 32 fields in VZ should turn over their assets to the state. This is just another round of nationalism as we have seen in other oil producing countries around the world. VZ decided it was not getting enough royalties off the countries oil and REQUIRED all these companies to tender their assets to VZ if they wanted to continue to operate. After signing the transitional documents the assets become a joint venture between the prior operating company and PDVSA, the state owned oil company. PDVSA will then inventory the assets and assign a value to the field. Once this value is determined PDVSA will tell the operating companies how much of a stake PDVSA will allow them to have in future production. Several companies including Petrobras, the Brazilian owned oil giant, have warned that the asset takeover could have seriously detrimental effects to future profits. No kidding. Venezuela has sharply raised taxes on these operating companies and declared new taxes on past production totaling billions of dollars. Needless to say the companies are under the threat of losing everything if they don't cooperate. I am sure some are just trying to stall for time in hopes of exiting VZ with the smallest possible loss. This kind of tactic by rogue governments will hasten the coming of peak oil. No foreign corporation will want to explore in VZ or risk any money spent on improving existing facilities. VZ claims production of 3mbpd but has been unable to meet this target for sometime due to the weakening infrastructure and lack of investment. VZ said OPEC was going to discuss a new price range for OPEC oil at the December meeting. Chavez has called for cutting production to push prices higher. With OPEC currently pumping at its maximum of 30.3mbpd and not able to build a cushion I doubt there will be a cut.

The OPEC president said he was going to recommend that production remain at 30.3mbpd despite the stated production quota of 28.0mbpd. He said they wanted to prevent any future price hikes. Sounds like everybody is not on the same page.

The energy rally returned most of our remaining plays to profit status as hoped and this trend could continue for a couple more weeks. As we get close to Christmas I am going to be making decisions about exit targets and year-end strategies but as always it will be based on price trends for oil and gas. We will be taking some short positions (puts) in early January in anticipation of a decline in prices into the March demand lull.

We are also working on a change in the LEAPS delivery process. Starting in January I will be able to issue entry/exit alerts on a daily basis as conditions change. Instead of leaving triggers open all week we will target them but enter only if the conditions are still right when the trigger is hit. Many times a trigger has been hit after a news item or some other event and I really did not want to be in the position given the new data. Hopefully this will give us the opportunity to manage the portfolio better and maximize profits. Yes, LEAPS are a long term investment but it all depends on your entry point. I want to be able to better pick those entries as the situation progresses.

For next week I hate to add any new entries with the expectation for an exit only 2-3 weeks away but I also hate to go into the winter with only six positions. I am going to make some suggestions in the watch list and maybe we can pick off a couple more on future volatility. Just be aware they will be short term positions.

Natural Gas Chart - 60 Min

Crude Oil futures Chart - 60 Min


Changes in Portfolio

New Plays


Dropped Plays
VLO$101.80Valero** Stopped at $96 **
STR$75.77Questar** Stopped at $74 **

New Watch List Plays Triggered


Portfolio Listing & Top Picks

New Plays

Most Recent Plays

None today.

Play Updates

Existing Plays

HW - $36.56 - Headwaters ** No Stop **

HW had a decent week moving to a new six week high and shrugging off the weakness that hit the other energy stocks early in the week. A reader emailed me this week and suggested that HW could be a takeover target by Peabody (BTU) since all of their products had to do with coal. While neither of us have any hard news to base this on I do believe HW at only $1.4B in market cap could easily be gobbled up by someone as the future coal picture becomes clearer. Maybe HW will be a longer term hold than I had anticipated.

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 $34

Entry $35.50 (11/22)


BP - $68.11 - BP Plc. ** No Stop **

BP gave me a lot of grief early in the week as the Monday massacre stretched into Wednesday but it finally recovered to close back at last weeks two month high. BP became the sole owner of the Olympic Pipeline in Western Washington state after buying shares previously held by Shell. The Olympic pipeline moves 12 million gallons of gasoline, diesel and jet fuel through Washington every day.

BP also signed its transitional agreement with Venezuela this week along with Shell. Negotiation at gunpoint.

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 - $101.80 Valero ** Stopped $96 **

Valero was doing so well the prior week rising to a new two week high but the Monday massacre knocked it back to $96 taking us out of the position. Once we were out VLO rallied back to set another new three week high on Friday. After the split I would consider getting back in for the long term at the $50 level with a long term put.

Valero will split 2:1 on Dec-16th.

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.

Entry $100 (11/09)

CHK - $30.52 Chesapeake Energy ** No Stop **

CHK finally caught fire as gas prices began to rise. The close on Friday was a four week high. Our patience has been rewarded but we still have an insurance put four months away. Volatility is not an issue here only cold weather and hopefully a return to something over $35 before year-end. The all time high is just over $40. If gas moves much over $15 it should be an easy reach.

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 - $57.10 Ultra Petroleum ** Stop loss $52 **

UPL broke resistance at $56 and has a good possibility to hit a new high over $60 before the week is out. UPL is a highly leveraged gas play and higher gas prices will build a fire under it. I would double up on any dip.

A reader asked me my target on UPL. That is a tough one to call. $60 is its historic high but a continued run on gas prices could see that broken easily. I would love to see $65 but I have no justification for that level. The key here is the price of gas. If it hits $15 again UPL should break $60 on a dead run. After that we just need to watch the demand cycle and the weather.

I raised the stop to $52.

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 - $75.77 Questar Corp ** Stopped $74 **

Questar took a massive hit on Monday with a drop from just over $78 to just over $74. I erred last Sunday when I posted the update on our put insurance being triggered. I changed the stop price on the chart to $70 due to being covered by the put but I forgot to change the header on this play description. Unfortunately that is the one that rules. Using the $74 stop we were hit on Tuesday morning and the play closed despite our put insurance. In hindsight given the lackluster rebound this week it may have been a mercy killing.

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, exit 11/29 @ $2.50, -3.10

Insurance Put
December $70 Put STR-XN @ 80 cents, 11/21, exit 11/29 @ 70 cents

Entry $78.76 (10/31)

COP - $62.36 Conoco Phillips ** Stop Loss $57 **

Conoco failed to return to resistance at $65 despite a lack of negative news. COP did say it was going to budget an additional $1.4 billion to upgrade the German refinery it was buying to be capable of more complex operations. COP has been weaker than some of the other major oils in November. This is probably due to the continuing outage of its Gulf refinery and fears that profits could be weakened. I like the COP story but when price does not follow you have to wonder if there is something you are not seeing. I am going to stick with COP over $60 and the 200-day average. Under $60 we will reevaluate.

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 - $61.97 Unitedhealth Group ** Stop Loss $57 **

UNH was the poster child for volatility this week with a plunge to $58.41 to cap a week of selling. The rebound was swift after UBS issued a buy on UNH and the stock closed at a new all time high.

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

Dropped Entries


New Watch List Entries

Current Watch List

BTU - $78.80 - Peabody Energy

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: $77.50
Buy March $85 Call BTU-CQ currently $5.40


PBR - $72.07 - Petrobras

Petroleo Brasileiro S.A. - Petrobras (Petrobras) is a wholly owned government enterprise responsible for all hydrocarbon activities in Brazil. The Company also has oil and gas operations in international locations, with the significant international operations being in Latin American countries. Petrobras is engaged in a range of oil and gas activities, which include segments like exploration and production; refining, transportation and marketing; distribution; natural gas and power; international, and corporate. During the year ended December 31, 2004, the Company had estimated proved developed and undeveloped crude oil and natural gas reserves of approximately 11.82 billion barrels of oil equivalent in Brazil and other countries.

Breakdown target: $69
Buy April $75 Call PBR-DO currently $4.30


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