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Weekly Newsletter, Sunday, 12/25/2005

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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

Is The Party Is Over?

They say the party is not over until the fat lady sings but in this case we are going to substitute Boone Pickens as the singer. Pickens appeared on TV this week saying that the delay of colder weather for nearly a month allowed gas supplies to build to comfortable levels and prices are now headed down. Nothing new to us because of the close watch we keep on the weather and gas demand but it appeared to be news to traders and they fled in panic.

Pickens said gas prices could decline to $9 and oil could decline to $53 before summer demand arrives. OPEC countered that oil prediction saying that they would cut production after January if prices fell any further. I have mentioned in the past that I thought OPEC would defend $55 on light crude. Any oil headed to heating oil sales in Jan/Feb is already on its way to us from OPEC and prices now reflect expectations for demand in the March/April time frame and the early spring demand decline. Pickens also said oil would hit $100 before the decade is out but reporters tended to under report that claim.

Gas storage levels declined -162 billion cubic feet in the report released on Thursday and many analysts had expected a draw of over 200 bcf. Analysts now claim that electric plants with switching capability were moving back to coal in the face of the high cost of gas. We heard confirmation from the Norfolk Southern Chairman on Friday that coal demand was stretching the limits of the railroads and there was a shortage of rail cars to carry it.

Gas prices fell to close at $12.28 on Friday with no cold fronts in sight. The holiday weather forecast is mild and consumption is likely to be well below levels seen the prior week. How much week-splitting we will see on the inventory report is unknown. We could see another sharp draw if the last bit of cold weather crossed weekly reporting boundaries. Regardless of the draw down the ramp for gas prices is likely over. The two coldest months of winter are still ahead but with supplies comfortably over the five-year average it would take a new ice age to cause a shortage. A massive draw of -250 bcf per week through February would severely dent supplies but leave nearly 1,000 bcf as a cushion. I seriously doubt any weather scenario that would cause those kinds of draws.

I believe we have seen the peak in oil/gas prices for December and once into January the decline in energy stocks could be significant as we head into the March/April lows. While this will take most of the energy plays out of our portfolio it will provide a great buying opportunity for some long term holds into the fall of 2006. The long term plan has always been to exit energy by the end of the year but I was hoping for one more weather bump.

In preparation for some energy exits I am adding a couple non-energy plays as we head into some possible January volatility. We got a textbook entry on the Freeport McMoran gold play last week when FCX pierced our $52 trigger point by -6 cents.

We also escaped a bullet on UNH when it traded down to $61.03 on Monday with the stop at $61. The rebound was swift and a new high was made on Wednesday.

I am going to keep the commentary short this weekend due to holiday concerns but will make up for it next week with an outlook for 2006 plays and market expectations.

Check all the plays for updated exits as we approach Dec-30th.

Merry Christmas and Happy Chanukah!


Natural Gas Chart - Daily


Crude Oil futures Chart - Daily

 


Changes in Portfolio

New Plays
DTX $426.68 Dow Jones Transportation Index
EXPD $69.50 Expeditors International
CSC $49.58 Computer Sciences Corp

Dropped Plays

None


New Watch List Plays Triggered
FCX $55.12 Freeport McMoran

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

FCX - $55.12 - Freeport McMoran ** No Stop **

FCX dropped on the drop in gold to hit our trigger point at $52 on Wednesday. The touch of support at $52 was all it needed to spark renewed buying and a sprint back above $55 and very close to a new high. The $10.4 billion acquisition of Placer Dome by Barrick Gold on Thursday just helped to fan the flames. Gold dipped to $492 to complete a -$50 drop from its highs. $500 should be interim support and a falling stock market in January should help to push gold higher as fears of a recession grow.

I am going to suggest the Feb-$50 Put as insurance against another drop in gold but only if FCX trades below $53 again. I believe any material drop in gold prices will be over the next two weeks and 2006 will see a return to the highs.

Company Info:

Freeport-McMoran Copper & Gold Inc. is a copper and gold mining and production company. The Company's principal asset is the Grasberg mine. Grasberg contains gold reserve and copper reserves. Its principal operating subsidiary is PT Freeport Indonesia. The Company owns approximately 90.64% of PT Freeport Indonesia, and the Government of Indonesia owns the remaining approximate 9.36%. PT Freeport Indonesia mines, processes and explores for ore containing copper, gold and silver. It operates in the remote highlands of the Sudirman Mountain Range in the province of Papua, Indonesia, which is on the western half of the island of New Guinea. PT Freeport Indonesia markets its concentrates containing copper, gold and silver worldwide. The Company also smelts and refines copper concentrates in Spain, and markets the refined copper products through Atlantic Copper, S.A., the wholly owned subsidiary of the Company among others, such as PT Irja Eastern Minerals and FM Services Company

2007 $55 LEAP Call OMT-AK @ $6.00

Insurance put: Feb $50 FCX-MK if FCX trades below $53.

Entry $52.00 (12/21)

DTX - $426.68 - Dow Jones Transportation Index

The Dow Transports have been in vertical mode since the October lows. The decline in oil/gas/diesel prices has given them wings and the strong growth in Q4 shipping sent them to new highs.

January has not been kind to the transports for the last five years. In 2005 the first three weeks of January saw a drop of nearly -400 points in the transportation average. In 2004 the decline did not begin until the 3rd week of January but continued for nearly -400 points. The decline in 2003 begin with the opening of trading for 2003 and continued for nearly -500 points to bottom on the week of March 9th. 2002 losses were somewhat moderate compared to 2003-2005 with only a decline of around -250 points but it did start with the opening of trading for 2002. 2001 was ugly with more than -575 points lost from the end of December high at 3157 to the March low at 2578. In 2000 the index fell from 3017 to 2260 for a whopping -757 point drop.

While nobody can forecast a repeat the combination of a new all time high just before a potentially weak January seems to be a match made in heaven.

The only fly in this ointment is the thin trading in the options. There are no leaps and future months don't even have put strikes near the current index level.

I am going to take the trade anyway and hope that new strikes are added before we get an entry. If not we will play what the dealer gives us.

I am also adding EXPD as a put candidate tonight for those who don't want to play in the thin DTX market.

I am not going to use insurance on this play as options are expensive. We are going to roll the dice and take our chances. If this is too risky for you please take the EXPD play instead. The difference between the two is a potentially large index move of 40+ points compared to a 10-point move in EXPD. Both could be very profitable.

We could have a new transport high next week but anyone that can do basic math should be very afraid of buying at the top ahead of January given the history for the last five years. I toyed with putting in a breakout/breakdown entry scheme but with the spike last week I was afraid it would collapse before we could get a decent entry. Option premiums could accelerate quickly.

This will be a hard entry for record keeping purposes at $426 but I strongly advise everyone to wait for weakness if we open with a spike on Tuesday. I would love to see a continued run to $450 on short covering into year-end.

We could easily see a dip to $370 over the next 90 days so buying a March put option at $400 is not unreasonable despite the index trading at $426 today. Since the $400 strike is the highest put strike listed for March and June that would be your best entry if none show up on Tuesday. Hopefully the market maker will add some on Tuesday with a new spike on the Transports.

The alternate strike would be the Feb $420 put just out of the money. A -40 point drop in the index would be a fat premium if it occurred before expiration in February. It is definitely possible.

Personally I am probably going to trade both strikes and roll out to a higher March strike when/if they become available.

Pick One but wait for weakness if we get an opening spike on Tuesday.

REPEAT - DON'T BUY UNTIL YOU SEE WEAKNESS or 12/30, whichever comes first!

Buy Feb-$420 Put DTX-NB currently $7.80
Or
Buy Mar-$400 Put DTX-OA currently $5.30

No insurance

Entry $426 (12/27)

EXPD - $69.50 - Expeditors International ** Stop Loss $75 **

EXPD is another way to play the anticipated roll over of the transportation sector. Unlike the DTX the options are liquid and cheap. EXPD spiked higher with the sector from $55 to over $72 on very little change in fundamentals. As you can see on the chart the spike is very unsupported. On a shorter term chart EXPD failed to near its highs on last weeks transport bounce and looks very likely to give back a majority of its gains should the transports in general suffer another January disaster.

This is not a negative indication of EXPD in general rather than just another way to play the potential transport weakness.

Company Info:

Expeditors International of Washington, Inc. (Expeditors International) is engaged in the business of providing global logistics services. The Company offers its customers a seamless international network supporting the movement and strategic positioning of goods. Its services include the consolidation or forwarding of air and ocean freight. In each United States office and in many overseas offices, the Company acts as a customs broker. It also provides additional services, including distribution management, vendor consolidation, cargo insurance, purchase order management and customized logistics information.

Buy May $65 Put URP-QM currently $2.70

No insurance due to cheap options

Entry $69.54 (12.27)

CSC - $49.58 - Computer Sciences Corp ** No Stop **

Computer Sciences was the target of a takeover back in October and the takeover failed because CSC wanted $65 and while the acquirers agreed in principle to that amount they could not structure a deal that made everyone happy. The parties agreed to disagree and discontinued talks. All parties said they could begin again at any time.

CSC spiked from $46 to $60 on the initial news but quickly fell back again as no further news was forthcoming.

I heard Crammer talking about it on Friday and his presentation made perfect sense. Since the acquisition talks CSC has signed several more contracts for nearly $5 billion dollars and more are in the wings. CSC is more valuable today than they were back in October. If you look at the news for CSC they are signing monster deals almost every day.

Since the talks were dropped General Dynamics paid $2.1 billion for Anteon, which valued them at 13 times earnings. At the $12 billion number discussed for CSC it values them at something less than 17 times forward earnings. CSC says they have more than $30 billion of projected deals in their defense Dept pipeline along with another $10 billion in non-defense bids.

The stock has been dormant at just under $50 since the talks ceased and the opportunity for the same buyout team or someone else to appear over the next year is very strong. As Cramer was saying on Friday there is little or no downside and only upside for CSC. After doing the research I believe him on this one.

Company Info:

Computer Sciences Corporation (CSC) is a provider of information technology (I/T) and professional services. Outsourcing activities include operating all or a portion of a customer's technology infrastructure and applications, and business process outsourcing. I/T and professional services include systems integration, consulting and other professional services and software systems sales and related services. CSC provides these services to customers in the Global Commercial and United States federal government markets. On a geographic basis, CSC provides services to Global Commercial customers in the United States, Europe and other international locations. Operations in Australia, Asia and Canada generate all revenue within Other International.

Buy 2007 $50 LEAP Call OSC-AJ currently $6.40 *preference*
Or
Buy 2007 $55 LEAP Call OSC-AK currently $4.00

I chose the $50 call instead of a higher call because any buyout offer caps the upside and time premium will evaporate instantly. We want to be as close as possible to the money on this one. A new $65 buyout number would turn the $50 LEAP into $15 overnight. The cheaper $55 LEAP would go from $4 to $10 so it is not a loser just a different way of looking at it. Both would represent about a +130% to +150% return. The difference would be in the buyout offer. Say they decided to take a $62 offer instead of $65. The lower strike would benefit most.

Insurance Put: June $45 Put CSC-OI only if CSC trades at $47.75.

Entry $49.62 (12/27)


Play Updates

Existing Plays

BTU - $83.43 - Peabody Energy ** Stop Loss $80.00 **

** Target $86 for a profit exit **

Peabody rebounded from the drop to $82 but not until the drop continued to support at $80.75. Despite the positive comments by several energy analysts about the increased use of coal instead of gas, Peabody failed to breakout of the $84 resistance. It is struggling higher but has yet to find traction. I tightened the stop just in case the lack of traction turns into a slide. I am targeting $86 for an exit.

I can't justify an insurance put today because put options are still too expensive. I added another insurance option below in case anyone wants to offset risk as we approach year-end. I would prefer to just keep a tight stop given the calendar and a decent entry last week.

Company Info:

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.


March $85 Call BTU-CQ Currently $5.80

Insurance Put: None, tight stop, puts too expensive

Insurance Call Option: Selling the Feb $90 call against the March $85 call would net you $2.40 in premium and a move to $90 by BTU would send the March $85 call to near $10. Closing both would result in a profit. However, in a decline to $80 the premium drop in the Feb call would offset the drop in the March call taking some of the risk out of the play. I prefer a tight stop instead.

Entry $81.88 (12/19)

PBR - $70.15 - Petroleo Brasilero ** Stop loss $68.50 **

** Target $72 for profit exit **

Petrobras rebounded sharply from last weeks dip but only returned to the $70 entry point. In keeping with the idea that warm weather has probably doomed the last energy bounce for the year I am targeting $72 as an exit. I had hoped to see one more strong bounce for gas stocks but it just does not look like it is going to happen. When we entered the play it was anticipated to be only 2-4 weeks so no surprise here. I raised the stop to $67.


Company Info:

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.


April $75 Call PBR-DO @ $3.50

Insurance Put: None

Insurance Call: None

Entry $70.00 (12/15)

TIE $67.06 - Titanium Metals ** Stop Loss $62.50 **

TIE is slowly wedging up to resistance at $67.50 and for nearly two weeks now there has not been any concentrated selling. The other titanium stock, ATI, has finally overcome the same two weeks of selling to breakout again. TIE is due to move higher soon as evidenced by the new high in copper on Friday. If metals are going to start moving again TIE should be the favorite of the momentum traders. Before two day December sell off TIE was jumping $1-$2 a day. Once over $70 I believe it will return to those winning ways.

The downside is the potential for more profit taking after Jan-1st. Those funds holding and hoping for a calm year end could turn into dumpers in January.

I am still not comfortable suggesting PUT insurance on TIE. As long as it is riding just over $65 the $65 puts are too expensive and the $60 puts are too far away.

If you chart the $75 call option TIE-CO it traded for $5.00 both times TIE declined to $61.50. That would only be a 60-cent loss from where it is this weekend.

Given the choices I would elect to go naked to $62.50 and take the early stop if we get another dip.

Company Info:

TIMET is the world's largest supplier of high quality titanium metal products. With its unique combination of strength, light weight, corrosion resistance and other metallurgical properties, titanium is used in hundreds of diverse aerospace, industrial and emerging applications where no other metal is as reliable or economical, especially on a lifecycle costing basis.

As a fully-integrated titanium manufacturer and distributor, TIMET's activities span every phase of titanium research, manufacturing and sales. We convert rutile ore into sponge; melt and refine ingot and slab; manufacture mill products; and distribute our products globally. We have the financial strength, capacity and technical solutions to meet the established demands for titanium and, as new uses for titanium accelerate, to lead the industry into the future.

Titanium Metals Corporation (TIMET) is a producer of titanium sponge, melted products and a variety of mill products for aerospace, industrial and other applications. For the commercial aerospace industry, the Company supplies titanium products to manufacturers of commercial airframes. Outside of aerospace markets, the Company manufactures a range of products for customers in the chemical process, oil and gas, consumer, sporting goods, automotive, power generation and armor/armament industries. Approximately 17% of the Company's sales revenue, during the year ended December 31, 2004, was generated by sales into industrial and emerging markets. TIMET markets and sells its products in the United States, the United Kingdom, France and Italy.

No LEAPS

March $75 Call TIE-CO @ $5.80

Optional Insurance: Canceled no entry

I prefer an early stop instead at $62.50.

Entry $64.95 (12/19)

VLO - $52.85 Valero ** No Stop **

Valero rebounded from the dip to $51.04 on Tuesday. Close enough to our put entry but not quite enough to trigger it. I am planning on holding VLO all year but would like to see a bounce back to the highs around $55 so we can get some $50 put insurance cheap. Let's target the March $50 put at $2 for an entry. It traded as low as $2.05 on Thursday. If we can get the entry I would take it and close the books on VLO until March. That would protect us for 90 days and get us to the expected low spot for energy stocks.

I picked the March $45 put for insurance but I do not want to enter unless VLO trades at $51. Target the $50 put instead as described above.

VLO should be a strong performer in 2006 with refining margins better than anyone else in the game. VLO has already made its low sulfur conversion in preparation for the new 2006 rules. According to VLO the new rules will remove 500,000 bpd of diesel from the market at a time when diesel usage is increasing. This will make the price for sweet crude rise while VLO is profiting from processing sour crude. If we can get one more good oil/gas spike into year end I want to take out the insurance and then forget about VLO for the rest of the year. We could easily see the price return to the $100 range if oil demand continues to rise.


Company Info:

Valero Energy Corporation (Valero) owns and operates 18 refineries having a combined throughput capacity, including crude oil and other feedstocks, of approximately 3.3 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.

2007 $60 LEAP Call VHB-AL @ $6.60

Insurance Put: March $45 Put VLO-OI currently $0.95
Enter put if VLO trades under $51.00

** Target the March $50 put for $2.00 on any bounce **


Entry $52.30 (12/16)

ESLR $10.43 - Evergreen Solar

I thought last week that maybe ESLR was the wrong solar company after SunPower (SPWR) spiked on news of a big $330 million contract in California. But, both companies lost ground after the decision for the million roof initiative was put off until the middle of January. Solar is going to be volatile until investors determine who the leaders are in the sector.

Evergreen Solar is a leader in the struggling solar space with installations all over the world. The key to any solar technology is volume and the California initiative officially announced on Tuesday would install one million solar assisted homes could be the push that makes solar finally affordable.

The California P.U.C. approval is the only roadblock and it is expected to be approved sometime in January after a 30-day comment period. ESLR is a competitor with improving technology and a real business model. They are yet to be profitable but are closing in on that goal. A true volume spurt as they would get from the million home project should assure that profitability through scale. Solar is the way of the future and the million roof project could be the key. The California initiative would also require home builders in CA to offer a solar component to any buyer by 2010. That would cover 150,000 homes a year.

California would subsidize up to $3.2 billion in solar roofing at the rate of $2.80 per watt over the next ten years starting in 2006.

Description of the plan:
http://www.cpuc.ca.gov/static/energy/051215_solaroverview.htm

http://www.latimes.com/business/la-fi-solar14dec14,1,1642908.story?coll=la-headlines-business

There is no guarantee this will be approved but the odds are very good. I believe in solar enough that I am willing to take the risk on ESLR even without the California initiative. Options are cheap and there is a strong upside if this catches on. Unfortunately there are no leaps. We will buy the June calls and move up to a farther date later if the play progresses successfully.

The Dept of Energy also has a million roof program in progress. http://www.millionsolarroofs.org/

Other companies in the sector are GE, Shell Solar, BP Solar, Kyocera Solar, PowerLight and SunPower (SPWR).

Company Info:

Evergreen Solar, Inc. develops, manufactures and markets solar power products enabled by its String Ribbon technology that provides reliable and environmentally clean electric power throughout the world. Its products are targeted at on grid and off-grid applications. The Company is developing technology at the wafer, cell and module stages of manufacturing, and it holds patents and other intellectual property in all three areas. In the String Ribbon technique, strings are pulled vertically through a shallow pool of molten silicon and the silicon solidifies between the strings to form a continuous ribbon of crystalline silicon. The ribbon is then cut and prepared for cell fabrication.

Buy June $12.50 Call QLU-FV @ $2.35

No insurance

Entry $11.71 (12/12)

OSTK $33.64 - Overstock.com ** Stop Loss $42 **

An excellent week for Overstock. It broke the $35 support level and failed to mount a credible rally after the drop and closed at the low for the week. When Buy.com pulled its IPO citing market conditions it was the death knell for Internet retail stocks. They are all likely to pull back until visibility becomes clearer.

OSTK is dropping so rapidly I removed the $30 profit target and we will play it by ear. If earnings disappoint for Q4 we could see the $20s. We will tighten the stop ahead of earnings but they are not until late January.

Play Description:

Probably the worst managed retail site on the Internet. The President, Patrick Byrne, blamed the poor performance of his stock on an evil "Sith Lord." (A Star Wars Character) Patrick continually ranks in the top five worst performing executives of a public company as rated by the Motley Fool. His latest claim to poor stock performance is the possible existence of "millions of counterfeit shares of OSTK trading on the Nasdaq." I am not kidding. He blames the SEC with being in collusion with the Nasdaq for refusing to disclose the number of counterfeit shares in the system. He warned "shareholders that the only prophylatic against hedge fund counterfeiting was to obtain the actual certificates from your broker and store them in a safe place." This would of course prohibit your shares from being traded. This was in response to a "Get Shorty" article in the WSJ.

Overstock has filed suit against several research firms claiming a conspiracy to drive its stock price down. Patrick claims research firm Gradient Analytics and Rocker Partners were at the center of a vast conspiracy aligned against Overstock. He warned that the criticism of Overstock.com will not go unpunished.

Patrick was forced to give up his role as Chairman in October with his father John Byrne taking back control. Patrick remains the president but that has not diminished his wild accusations.

The company has a good business model but has failed to execute on so many levels that it should be criminal. They have the worst customer service of any E-Commerce site I have every visited. I have made several purchases in the past from OSTK and all but one were botched terribly. The products come in an unlabeled box with no return address label and no invoice. You can't return them without some serious effort. Consumers will not put up with this when other companies like Amazon.com, NewEgg.com and Ecost.com are models for the industry.

Sales at OSTK have slowed and operating expenses are growing faster than revenue and marketing costs nearly doubled in Q3. Cost of acquisition for new customers rose +30% over the prior quarter. This is a signal that competition is winning the battle and prior customers are not returning. OSTK has a huge debt load and slowing sales will not help. Morningstar gives them a D+ for financial health and an F for profitability. Analysts are dropping estimates for the stock into the high $20 range and well below current prices.

In August, Patrick Byrne held a conference call in which he basically said that everyone from hedge funds to journalists to regulators had all been scheming to destroy his company. He said the plan was being orchestrated by someone he identified only as the "Sith Lord." He really said that. Rob Plaza at Zachs Investment Research said when a CEO is putting the focus on things he can't control like short interest there could be a bigger problem he does not want you to see. He said an even bigger problem is when management blames regulators for stock manipulation you have a real problem.

The last really dumb statement, or was it, came from Patrick on Nov-10th. He said "I don't give stock advice but the average investor should probably steer clear of Overstock." That advice I will follow.

Company Info:

Overstock.com, Inc. is an online closeout retailer, offering discount, brand-name merchandise for sale primarily over the Internet. The Company's merchandise offerings include bed-and-bath goods, home decor, furniture, kitchenware, watches, jewelry, computers and electronics, sporting goods and apparel and designer accessories. It also sells books, magazines, compact discs (CDs), digital versatile discs (DVDs), videocassettes and video games (BMV). The Company also offers limited travel services. Overstock.com offers approximately 50,000 non-BMV products and approximately 500,000 BMV products in eight departments on its main Website, www.overstock.com. Overstock.com has a direct business in which it buys and takes possession of excess inventory for resale. It also has another worldstock Website, www.worldstock.com, through which artisans in the United States and around the world can sell their products.

No LEAPS

June $35 Put QKT-RG @ $5.00

No insurance.

Entry $38.51 (12/12)

KKD $ 5.66 - Krispy Kreme Doughnuts ** Stop Loss $6.25 **

The support at $6 finally collapsed on Thursday and KKD has begun moving down again. For several days the range was barely over 3 cents! Likely some investor thought they could acquire a position and though that support attract other investors back to KKD. Apparently there was more stock for sale than he had money or he got smart and pulled back to wait at $5. If you look at a 30 min chart on KKD the battle over the last two weeks is very obvious.

The NYSE has given them until mid January to file their reports or be booted from the exchange. However, the creditor deadline for financials of Dec-15th was suddenly extended to April 30th. Despite a resignation from the board and an admission on Tuesday that losses were going to be higher than previously expected the stock refuses to fall. Every dip is quickly bought but we are seeing increasing selling pressure as well. On Friday the stock traded in only a one-cent range for nearly all the day. Very strange behavior. This stock could either break or spike very soon and for reasons not readily apparent.

I lowered the stop loss to $6.25 but with a $1.25 option it is not going to matter much other than ending the play. The difference in option price will be negligible.


Play Description:

Trouble is mounting for KKD. They have not filed financials since November 2004 and they are probably going to miss the Dec-15th deadline imposed by creditors. They warned this would happen about 10 days ago. They are having to restate financials for several years due to errors in accounting for expenses, loans and franchisee info.

The CEO Scott Livengood and other top executives were ousted earlier this year on allegations of financial misdealing and securities fraud. Suits are mounting from numerous groups, debtors, employees, franchisees and vendors over all types of non payment, fraud and failure to follow through with agreements.

Stephen Cooper, a turnaround specialist, took over the reins when the officers were evicted. So far the news has only gotten worse. Stores are closing rapidly including prior showplace stores and once leading producers. Cooper has worked on prior disasters including Polaroid, TWA, Enron and Boston Chicken. That list should give you a clue what is ahead for KKD.

Cooper said the chain cannot operate 4,000 square foot stores profitably and will try to reinvent itself as a smaller, leaner company. They are closing unproductive stores in a reasonable and rational fashion according to Cooper. He wants to focus on increasing sales of coffee and other beverages.

I have written about the similarity between KKD and Boston Chicken for several years and warned numerous times at much higher levels that KKD would end badly just like Boston Chicken. Now the Boston Chicken CEO is running KKD. Amazing prediction.

Yes, Boston Chicken was turned into a profitable entity once again. However it was done at the expense of shareholders. The common stock was cancelled the ownership of the stores was turned over to the debt holders. Boston Chicken wins, investors lose.

I believe that the NYSE will eventually tire of the endless deadlines for financials and will delist them. If that happens it will be the kiss of death for funds still holding the stock and hoping for a miracle return to the $105 levels of yesteryear.

Options are cheap and the KKD story is just waiting for Cooper to write the last chapter. KKD wins, shareholders lose.


Company Info:

Krispy Kreme Doughnuts, Inc. is a specialty retailer of doughnuts. It owns and franchises Krispy Kreme doughnut stores where the Company makes and sells over 20 varieties of doughnuts, including its Hot Original Glazed variety. Each of its traditional stores is a doughnut factory with the capacity to produce from 4,000 dozen to over 10,000 dozen doughnuts daily. Its sales channels consist of on-premises sales and off-premises sales. The Company has two complementary business units: its company and franchised stores, which Krispy Kreme refers to, collectively, as Store Operations and Krispy Kreme Manufacturing and Distribution (KKM&D). At February 1, 2004, there were 357 Krispy Kreme factory stores in operation, of which 338 are located in the United States. During the fiscal year ended February 1, 2004 (fiscal 2003), it acquired the remaining 33% interest in Golden Gate Doughnuts, LLC that it did not already own.

2007 $5.00 LEAP Put OKK-MA @ $1.35

No insurance

Entry $6.01 (12/12)

HW - $36.69 - Headwaters ** No Stop **

Finally some movement from HW! The two months of consolidation broke out to the upside and we appear to be moving again. The lift as we approach year-end has given us an opportunity for a free ride until May.

We currently have no insurance on this play. Looking at the option chain I see that the May $40 call ($2.05) is approximately the same price as the May $35 put ($2.15). I don't believe HW will exceed $40 by May if we get any downdraft in January. By selling the May $40 call against our $40 LEAP and use the proceeds to buy the put we have free insurance at $35 until May. If HW does catch fire we can stop out on the May $40 call for a minor loss that will be offset by our gain in the $40 LEAP. That is my recommendation for Tuesday.

********

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

Dec-27th Insurance Combo:
Sell May $40 Call HW-EH currently $2.05, set stop at $39.95
Buy May $35 Put HW-QG currently $2.15

Entry $35.50 (11/22)

CHK - $32.19 Chesapeake Energy ** No Stop **

CHK failed to hold the highs at $34 and is looking weak again as gas prices tumble. I really agonized this weekend on how to play this. $12 gas is still very profitable for CHK. Heck, $9 gas is still a 400% profit compared to their average cost of just over $2. BUT, do investors understand that just because gas is off its highs it is still very profitable for the gas producers?

Ours task is not to try and understand what other investors will think and instead try to make rational decisions about the fate of our play. While I think gas above $9 will continue to be profitable not to mention any hedges they placed over $12, I am afraid CHK could begin a decline along with gas prices in January.

We currently have an April $25 put as insurance but CHK has risen so far that it is worthless as insurance. I don't want to incur additional expenses adding insurance at a higher level. However, I have no problem selling an April call to offset any declines ahead.

The April $35 call is $2.15 today and would offset 50% of the cost of our LEAP. We could then afford to watch the fireworks from the sidelines comfortable in the knowledge that we have downside protection in the form of additional income and from the distant put.

Sell the April $35 Call CHK-DG currently $2.15
Set a stop loss on the call at $34.95

That protects us until April against any unforeseen changes.


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
Covered Call 12/27:
Sell the April $35 Call CHK-DG currently $2.15
Set a stop loss on the call at $34.95


Entry $29 (11/04)

UPL - $57.49 Ultra Petroleum ** Stop Loss $55.75 **

Set a stop at $55.75 and an exit target at $60.

UPL is holding its ground just under resistance at $60 and still in an uptrend. The same gas conversation I used in CHK works with UPL as well. We do not currently have insurance for UPL. Because the option on UPL is a March call we really do not have any options that make sense for hedging this play. If gas tanks, UPL will tank. We are down about a buck on the call and UPL is in a slight uptrend since the lows on the 16th. There is a slim chance we will get a year end boost next week as investors put all those year end bonuses to work. Instead of trying to stretch some kind of insurance on UPL I would rather just raise the stop and set an exit target. If we get a spike we get out clean, if not we lose the buck and some change.

Set the stop at $55.75 and the exit target at $60.

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)

UNH - $63.64 Unitedhealth Group ** Stop Loss $62.50 **

** Profit Target $65.00 **

UNH is still hugging $64 like a security blanket but it can't seem to make a break higher. The sharp dip last Monday scared me and I am afraid there are more sellers just waiting for the calendar to turn over to January 3rd. We are up +$4 in the LEAP and I expect some selling in January. I set a profit target of $65 and raised the stop to $62.50. Any movement at all and we will be out.

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 $55.

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

Insurance put: CANCELLED NO ENTRY
March $50 Put UHB-OJ

Entry $56.75 (10/31)

 


Leaps Trader Watch List

Dropped Entries

None


New Watch List Entries
DJX
$108.88
Dow Jones Industrial Average

Current Watch List

DJX -$108.88 Dow Jones Industrial Average

The Dow has struggled to touch 11000 for the last month and has failed to pass even the 10984 we saw back in March. It has found resistance to be strong and the clock is running out on 2005.

The analysts seem split on which will come first, 9,000 or 12,000. We really don't care because this play is strictly a timing play based on the historical January weakness of late.

We are going to use the DJX because options are cheap and there are plenty of strikes.

This is going to be a short-term play, probably less than 60 days. It will be target driven for both entry and exit. There will be no insurance but we will establish stops once in the position.

We are going to add to the position on any Dow gains through Jan-6th. Add one contract, two, ten or a dozen at each trigger point. It is up to you. Since we cannot know what the Dow will do we want to average cost ourselves into a put position at Dow 11000. If it only reaches 10950 we will only have 2/3 of our target position.


Breakout target: $109.00 (Dow 10900)
Buy March $108 Put DJV-OD currently $1.80

Breakout target: $109.50 (Dow 10950)
Buy March $108 Put DJV-OD

Breakout target: $110.00 (Dow 11000)
Buy March $108 Put DJV-OD

If the Dow hits 10900 but does not reach 10950 then add to your position on any breakdown to 10800.
 

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