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Weekly Newsletter, Saturday, 01/21/2006

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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

Very Tough Week

It was a tough week for me rather than a tough week for the portfolio. Every tick higher in oil prices adds another pound to the weight I am carrying for not being fully invested in energy stocks. I know there has not been any fundamental support for the rising prices and no way to have foreseen the various afflictions currently hampering the oil patch. Still it ticks me off to see prices moving higher and not be fully invested in oil.

Looking back every weekend seemed to be a new peak in prices with inventories rising not falling. Why would anyone want to buy the top ahead of a potentially weak period in the cycle? I can't imagine a more risky play. However, each week something new appears to push prices higher. In just the last four weeks oil has risen from $58 to $68 at a time when demand should be falling. Typically February and March is the lowest demand of the year and the time when refineries shutdown for extended periods for maintenance, upgrades and to shift production from heating oil to gasoline. Oil demand during this period drops substantially with many refineries offline for weeks at a time. Sometimes you can do exactly the right thing for the right reasons and end up on the wrong side of the market. That is what I feel today. I could not in good conscience recommend new energy plays ahead of this demand drop. The demand is slowing as expected but the prices are soaring instead due to geopolitical issues. Who knew?

I explained all about Iran and the oil card in this weekend's Option Investor commentary so I will not repeat it here. Other factors pushing prices higher are outages in the North Sea of more than 350,000 bpd due to six platforms being shut for various problems from fires, damage, emergencies and weather. Nigeria, an exporter of light sweet crude has lost over 200,000 bpd due to increased rioting and attacks by rebels. The situation is not expected to get better any time soon. There is still more than 400,000 bpd offline in the Gulf of Mexico and 225,000 bpd are not expected to return to production before the 2006 hurricane season arrives. There seems to be no end to problems in the oil patch with South America political tensions rising almost daily.

Goldman Sachs said prices could hit $70 by summer and CIBC World Markets said $100 was not out of range for 2006. CIBC went as far as to claim Peak Oil for conventional oil production had arrived in 2004. They categorized deepwater drilling as "non-conventional" and that took a substantial amount of current production out of conventional, which backdated the Peak for conventional. This application of terms is just additional confusion for the Peak Oil conversation but the bottom line is still the same. Regardless of how you categorize different types of production the total production number is still the same. While almost nobody expects the global peak in 2006 there is strong evidence it could come in 2007. But, that is another story.

Today we have to make a decision on adding additional oil positions. Each day that oil rises and the leading oil stocks hit new highs my indigestion level rises. However, we can't let these issues force us into an emotional decision. According to several oil analysts I follow at least $10 of the current price of oil is related to those geopolitical concerns listed above. Should tensions ease the price of oil could hit $58 very quickly.

While the Iran problem is not going away any time soon it is also not going to come to a head for several months. Once the news fades we could see reduced pressures on oil prices until it heats up again in the fall. It could take months to make it to the security council and Russia and China both have a veto that could remove it from consideration. I can't justify investing on oil at an all time high based solely on Iran.

The North Sea problems will be resolved shortly and production restored. That is the easiest of the problems to bet on. It is a sure bet that production will be restored soon. The problems in Nigeria may not go away but they can't get much worse. Of the 350,000 bpd that could be impacted due to a total shutdown of Shell's operation more than 200,000 are already offline. The odds of much more being taken out are slim. There may be some small amounts but it would be nearly impossible to shut them down completely. Production in the Gulf of Mexico is slowly returning. 175,000 bpd is expected to come back online over the next 30-60 days. Nothing should interfere with that process.

Increased oil prices are producing higher gasoline and diesel prices and that should keep a lid on demand during Feb/March. That will help inventories build and take the pressure off oil prices.

All of this is simply conventional wisdom based on the theory that no new disruptions appear. Problems will be resolved and demand will slow over the next two months. Prices should revert back to the 50-day average between now and the summer demand cycle. "Should, could, might and probably" are the key words in the preceding paragraphs. Nothing guarantees oil prices will go down.

However, that puts me right back between the same rock and hard place that I have been in for the last four weeks. To buy the potential top or wait for a retracement. Despite my extreme consternation about the missed profits I refuse to buy the top. Friday's close at $68.55 was a four-month high. The post hurricane high on the now current March contract was $70.95. I would like to believe that $70 is a sentiment top that will hold. The term double top comes quickly to mind. Yes, hope springs eternal.

Right now support at $64 looks like a bargain but stronger support at $58 would be a much nicer retracement. No, I am not on drugs but living on hope. We all know how fast oil corrects when traders take profits and we have seen many $5-$6 drops that occurred in just 3-4 days over the past several months. Eventually we will get a drop like that. You may remember the last one from $63.45 to $58.10 that occurred between Dec-13th to Dec-21st. That was the one that stopped us out of our last batch of oil plays with the selling climax on the 27th.

Of course there is always the question of the demand slump. Given the time of year it is always possible we could get a retracement all the way back to $58. Wishful thinking maybe but a danger to us if we take an entry in the $62-$64 range I am expecting. It means we need to plan on spending the extra bucks for insurance once triggered.

Natural gas plays are history unless a new ice age arrives soon. Warmer weather continues to allow inventories to remain well over the 5-year average and the clock is rapidly expiring on winter. CHK is struggling to break resistance at $34 and without some cold weather it may be a futile attempt.

Our non-energy plays are doing well, especially Overstock.com. The transportation plays were on the right track until the Thursday short squeeze tacked on a +78 points to the transports. The trend has resumed but we have to sweat out the recapture of those points while we wait for a lower low.

Krispy Kreme is begging the NYSE for an extension to avoid being delisted on Jan-30th. So far the NYSE has not granted it since it would be only one more in a long line of extensions. KKD has not filed financials since 2004. If they do grant the 90 day extension I will exit the play. The original idea was to be short when the delisting occurred to capitalize on the fund flush just before being kicked off the exchange. Many funds cannot own stocks not listed on a major exchange. KKD dropped about -20% on the news over the last week.

The drop in housing numbers last week accelerated the drop in LEND and MTG and gave us a margin of safety in each of those plays.

I am adding some plays to the watch list this week in hopes an oil retracement is near. With the February crude contract expiring on Friday it is always possible the end of week buying was fueled by expiration reasons rather than by political ones. I have illustrated the expiration gyrations on contracts in the past and I want to be ready if lightning strikes again.


Dow Transports Chart - Daily

Natural Gas Chart - Daily

Crude Oil futures Chart - Daily

 


Changes in Portfolio

New Energy Plays New Non-Energy Plays

None


Dropped Plays

None


New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

None
 


Play Updates

Existing Plays

MTG - $65.09 - M.G.I.C. Investment Corp ** Stop $70.00 **

MGIC finally cracked on Friday ending down over -$2 for the week. Declining home sales and fears of a weakening consumer helped to apply the pressure. No change in the play but I did lower the stop.

Original play description:

MGIC provides mortgage insurance to lenders for borrowers with high loan to value ratios. The borrower pays the mortgage protection insurance premiums with their monthly payment. With the very high loan to value mortgages of the last couple years MGIC has a rising risk of default. Earnings were on Thursday and revenue fell -8% along with a net decrease in premiums received of -8.2%. New insurance written also fell. The percentage of delinquent loans at year-end rose to 4.52% from 3.99%.

I know several homeowners, three in the same block, that are only days/weeks away from foreclosure and everyone had taken advantage of the accelerating home values to refi, some more than once. Home values have fallen nearly -20% in this Colorado area despite what you read in the papers. The foreclosure boom is coming and MGIC will suffer.

Company Info:

MGIC Investment Corporation is a holding company that, through its wholly owned subsidiary, Mortgage Guaranty Insurance Corporation (MGIC), provides private mortgage insurance in the United States to the home mortgage lending industry. Its principal products are primary mortgage insurance and pool mortgage insurance. Primary mortgage insurance may be written on a flow basis, in which loans are insured in individual, loan-by-loan transactions, or may be written on a bulk basis, in which a portfolio of loans is individually insured in a single, bulk transaction. It is licensed in all 50 states of the United States, the District of Columbia and Puerto Rico. In addition to mortgage insurance on first liens, the Company provides lenders with various underwriting and other services and products related to home mortgage lending through other subsidiaries.

Buy 2008 $65 LEAP Put YHM-MM currently $6.50
(No 2007 $65 put exists)

Insurance Call: None

Entry $67.22 (01/15)

LEND - $45.60 - Accredited Home Lenders ** Stop Loss $52 **

Finally a -$5 drop in LEND for the week. Earnings are not until Feb-14th so plenty of time for a drop to test support at $42.

Target support at $42 for a profit exit.

Original play description:

LEND is a sub-prime mortgage lender. Another way to put that would be to say they lend money to those with weak credit. If the housing market is really slowing and housing values declining then sub-prime lenders could be in trouble.

We have already seen mortgage application rates sink to levels not seen since 2004. The Mortgage Application Index decreased to 545.9 last week, -17% below the level from just four weeks ago and more than 10% below the same period in 2004. Refinancing has fallen to levels -20% below 2004 levels.

The days of the mortgage-refi to get out of debt are gone. Tighter loan restrictions and higher default rates are commonplace across the country. I have a son in the mortgage business and he claims applications have fallen through the floor and restrictions are rising. Borrowers who refied a year ago can't get an approval today despite substantial equity left in their homes.

Option loans, where the lender gives the borrower a smaller payment for the first 2-3 years have evaporated. Even ARM loans are falling, down -4% in the latest numbers.

Ironically Fannie Mae and Freddie Mac raised the limits for conforming loans by +16% as of Jan-1st. This means the conforming loan limit for a single-family property rose from $359,650 in 2005 to $417,000 as of Jan-1st. This should increase the level of loans except that property values are slowing and credit criteria is rising.

The Mortgage Bankers Association expects loan originations to fall by -18.6% in 2006.

In October National City said loan profits fell -91% over the same period a year earlier. H&R Block blamed a $86 million loss on a drop in income from its mortgage unit.

If this trend continues sub-prime lenders may have to set aside more money as reserves to cover defaults at a time when loan initiation profits are also shrinking. The smaller pie available to all lenders is making competition for loans even more cutthroat. Many lenders MUST do loans to survive and they will be forced to take lesser credits, greater risks and receive less income for those risks.

Lenders are already slashing staff in an effort to maintain profitability.

LEND published an earnings outlook on Dec-19th for Q4. They said they expected to earn $7.70 to $8 per share compared to analysts estimates of $7.74. HOWEVER, Accredited Chairman and Chief Executive James Konrath said that the projected earnings target depends largely on pricing in the nonprime mortgage market and assumes growth in loan originations but lower costs of origination. That is a very big IF. I could make a million dollars next month if I could pick the exact top in January and then short 1000 SPX futures contracts. That is not going to happen. LEND may reach its targets but there is still trouble ahead.

I am only using a June Put option on this play despite LEAPS being available. All lenders will see a spike in loans in April/May as the summer selling season arrives. I would like to be out by then.

Company Info:

Accredited Home Lenders Holding Co. (Accredited) engages in the business of originating, financing, securitizing, selling and servicing non-prime mortgage loans secured by residential real estate in the United States. Accredited focuses on borrowers who may not meet conforming underwriting guidelines because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, or past credit difficulties. The Company originates loans primarily based upon the borrower's willingness and ability to repay the loan and the adequacy of the collateral. Accredited originates its loans primarily through independent mortgage brokers across the United States and, to a lesser extent, through its direct sales force in its retail offices.

Buy June $45 Put QFW-RI currently $4.70

No Insurance: LEND hit an all time high in December at $51.70. I put the stop just over that high.

Entry $47.45 (01/08)

FCX - $57.35 - Freeport McMoran ** No Stop **

FCX surprised everyone with earnings that more than doubled the same quarter in 2004 and beat analyst estimates by +39 cents. These record results pushed FCX to a new high at $63.39 but traders quickly bailed and took profits as gold weakened on Wednesday. Gold rallied to a new high on Friday but the market weakness knocked another -1.55 off FCX. Support is $54 with a speed bump at $57.

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 @ $53.

Entry $52.00 (12/21)

DTX - $415.97 - Dow Jones Trans Index ** Stop 430 **

A huge range in the DTX this week with a drop to 406 followed by a spike to 425. After the smoke cleared it settled within one point of last week's close. No change here and a weak market could accelerate the drop.

Original play description:

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 add EXPD as a put candidate 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.

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

No insurance

Entry $426 (12/27)

EXPD - $67.28 - Expeditors International ** Stop Loss $71 **

Like the transportation index EXPD had a wide range for the week from $65.65 to $69.66 but settled within 50 cents of the prior week's close. Support remains at $66 and earnings are still two weeks away. Any continued market weakness should produce a breakdown of the Q4 gains.

Target $60 as a profit exit.

Original Play Description:

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.

May $65 Put URP-QM @ $2.70

No insurance due to cheap options

Entry $69.54 (12/27)

VLO - $60.29 Valero ** No Stop **

VLO set another new all time high on Friday and we are in very good shape to see VLO continue higher even if oil prices slip. The summer refining season is approaching and VLO profits will continue to flow. No change in the play.

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. The effective date for Diesel is June-2006. This will make the price for sweet crude rise while VLO is profiting from processing sour crude. 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 gasoline, 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 @ $1.20
Put entered on 12/27 when VLO traded at $51

Entry $52.30 (12/16)

OSTK $25.07 - Overstock.com ** Stop Loss $36 **

** Target $20 for a profit exit **

It was a quiet week for Overstock with no public appearances by the President and no news of additional attacks by the Sith Lord. Overstock is due to report earnings soon but they are no longer posting a current date on their website. I went back to their earnings warning and they said sometime in late January or early February. I would bet on February since they already warned.

Overstock is already down -$13.35 since we entered this PUT position and we are up +$6.70 on the option. I hate to lower the stop since frequent media appearances by Patrick Byrne tend to create volatility.

Continue to target $20 for a profit exit and we will visit this play again next week as we near earnings. Friday's close was another new two-year low.

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 their only prophylactic 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 LEAPSS

June $35 Put QKT-RG @ $5.00

No insurance.

Entry $38.51 (12/12)

KKD $ 5.06 - Krispy Kreme Doughnuts ** Stop Loss $6.00 **

KKD is starting to crumble as the deadline for delisting approaches. Jan-30th is the date and KKD is begging the NYSE to give them 90 more days. They have not filed financials since 2004 and should have been delisted a long time ago.

If the NYSE does agree to a 90-day extension I am going to exit the play.

The dip to $3.35 on Wednesday was in response to a news comment on the potential delisting. It was brief and was quickly bought proving that buyers exist at a price as long as the stock is listed. A delisting can cause many funds to dump the stock as they are prohibited from holding companies not listed.

This should be our week in KKD. We will either be out or highly profitable depending on the news.

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 have 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 - $35.09 - Headwaters ** No Stop **

HW completely retraced its gains over the last month and retreated from its new three month high set the prior week. We are back at support at $35 but now we have a May $35 put to protect us.

We are protected against any drop due to the insurance we took out on Dec-27th.

********

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 - $33.53 Chesapeake Energy ** No Stop **

CHK is slowly moving higher despite the lack of gas consumption. Gas prices are holding at $9 and well above the $6.81 we saw last January. The decline in gas prices from $15 should have knocked CHK back into the high $20s but the insider buying and the rise in oil has maintained support. I would be surprised to see CHK break the $35 level before summer but then anything is possible.

Since we sold the April $35 call against our leap we should be perfectly happy to watch and wait as long as $35 is not broken. With our downside put in place there is little risk and gas prices will end 2006 higher than 2005. Be patient.

Keep that stop loss on the covered call at $34.95 just in case we get a sudden surprise.

Insider Trading:

A reader alerted me to the insider buying on CHK, (thanks Joe!) and I must say it is amazing. The Chairman and the President made a total of 14 market buys between Dec-14th and Dec-27th totaling over $73 million. That is an obscene amount of confidence and suggests to me that something is going on at CHK and their outlook is extremely positive. With a market cap of $11 billion they could be a takeover candidate made much more possible by being the third largest holder of gas reserved in the U.S.

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)


Leaps Trader Watch List

Time to Nibble?

No, it is not time to buy energy stocks but I am going to put a couple on the list just in case we do get a real correction in oil prices.

There is no magic here but just good companies that should not be as susceptible to oil volatility as others.

I would love to see a -10% correction in oil prices, which would take oil back to around $64. That may be wishful thinking given the geopolitical problems but at least I can hope.

February and March are typically the slowest demand months of the year for oil and the period where refineries shutdown for maintenance, upgrades and to shift from heating oil to gasoline. Let's hope this year is no exception.

We also have the earnings cycle to deal with and maybe expectations are just a little high for some companies. That would help create some volatility for an entry.

Dropped Entries

None


New Watch List Entries

None

Current Watch List

DO - $81.02 - Diamond Offshore Drilling

Diamond Offshore Drilling Inc. engages principally in the contract drilling of offshore oil and gas wells. As of December 31, 2004, the Company had a fleet of 45 offshore rigs consisting of 30 semisubmersibles, 14 jack-ups and one drillship. Diamond offers a range of services worldwide in various markets, including the deep water, harsh environment, conventional semisubmersible and the jack-up market. Its principal markets for its offshore contract drilling services are the Gulf of Mexico, including the United States and offshore Mexico, Europe, principally the United Kingdom and Norway, South America, Africa and Australia/Southeast Asia. From time to time, its fleet operates in various other markets worldwide. Diamond provides offshore drilling services to a customer base that includes private and independent oil and gas companies and government-owned oil companies.

Breakdown target $72.00
Buy 2007 $80 LEAP VCT-AP

*********************

RIG - $78.66 - Transocean Inc

Transocean Inc., formerly known as Sonat Offshore Drilling Inc., is an international provider of offshore contract drilling services for oil and gas wells, related equipment and work crews, primarily on a dayrate basis, to drill oil and gas wells. The Company operates with a particular focus on deepwater and harsh environment drilling services. The Company also provides additional services, including management of third-party well service activities. The Company's transocean drilling segment consists of drillships, semisubmersibles, jackups and other drilling rigs.

Breakdown target $70.00
Buy 2007 $80 LEAP VOI-AP

*********************

COP - $64.62 - Conoco Phillips

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.

Breakdown target $60.00
Buy 2007 $65 LEAP OJP-AM

***********************

SU - $72.72 - Suncor Energy

Suncor Energy Inc. (Suncor), formerly Suncor Inc., is a Canadian integrated energy company that explores for, acquires, develops, produces and markets crude oil and natural gas, transports and refines crude oil and markets petroleum and petrochemical products. Periodically, the Company also markets third-party petroleum products. Suncor also carries on energy trading activities focused principally on buying and selling futures contracts and other derivative instruments based on the commodities the Company produces. The Company has four principal operating business units: Oil Sands; Natural Gas; Energy Marketing and Refining, Canada, and Refining and Marketing, United States of America.

Breakdown target $65.00
Buy 2007 $70 LEAP OYX-AN


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