Option Investor
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Weekly Newsletter, Saturday, 02/25/2006

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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

That Was Fun!

The rebound of oil to $63, crash back to $59.65 and rebound to $63.25 in only four days sent energy stocks in motion like a leaf in a hurricane. Fortunately we were not stopped out on any energy positions but unfortunately we were not triggered on any new watch list entries either. The volatility was too fast and geopolitical fundamentals too strong for stocks to suffer much damage.

I expounded on the various world events impacting oil in my Option Investor commentary this weekend so I won't repeat it here. I do believe that al Quaeda will eventually be successful in damaging the Saudi infrastructure. It is simply a matter of time. I believe Chavez will eventually restrict oil deliveries to the U.S. once he has contracts in place with other countries. Venezuela can't pump at full production due to lack of investment in the fields so he has no excess capacity. Anything he sells to someone else he will not have available for export to America. Somebody in the U.S. will eventually buy the Citgo refineries from PDVSA. Chavez will then be free to cut off the oil since his retail profits will not be endangered. Nigeria rebels will not go away. The country is too poor and the rebels are heroes to those in need. All these problems will continue to support prices on a long term basis but there will be short term swings.

Iran is the next real problem. Their nuclear ambitions are scheduled to be reviewed by the UN in early March and that should provide another war of words and threats from both sides. Since an attack on Iran by somebody could eventually impact its energy production that will always be a wild card in the deck.

Iraq is in full blown civil war and while the hostilities are between religious sects today it just provides another reason for somebody to attack pipelines. Insurgents will be trying to take advantage of the unrest to up their activities against the troops on the ground and the evil Satan through attacks on oil.

These events should combine to offset any normal spring decline in prices that occurs in four weeks surrounding March 1st and that means the lows for the spring could be behind us. It would be folly to bet the farm on that but we should continue to buy the dips and add to positions when they are offered.

With the summer rally energy ahead of us we are positioned to take full advantage of whatever forces push oil higher. Our last non-energy position was stopped out on Wednesday when MGIC Investments (MTG) spiked higher nearly +$3 higher on three times the normal volume on no news. We were stopped out by only 7 cents before the decline resumed. Since MTG just authorized a new 10 million share buyback program it is entirely possible that was them in the market supporting their own stock price as it neared a new four month low. Either way we are out and are now entirely energy driven.

Natural gas prices remained firmly above $7 all day Friday and locked in the $7.30-$7.50 range in defiance of the extreme overabundance of gas in storage. Just before the close they were slammed back to $7.00 where they have found support for the last two weeks. Gas prices are not getting off the matt it appears and it is only a matter of time before that support breaks. Discussions about two different pipelines, one from Alaska and one from Alberta Canada prompted industry experts to discuss the gas shortage. The outlook coupled with a -123bcf draw in supplies for the week helped provide support but $7 is doomed as we approach the spring demand slump.

Gasoline supplies are rising as refiners switch to the summer products. I got a kick out of one talking head this week predicting an abundance of gasoline over the coming years. You only need to look at the facts to know he was wrong. Current global vehicle production is around 30 million units per year. (US 17M, China 6M, Japan 1M, Germany 1M, Others 5M+) Between now and the end of 2010 that amounts to an addition of nearly +150,000,000 vehicles to the global consumption pool. Using a very minimal consumption average of only 10 gallons per week that represents new consumption of 150 million gallons per week, 36 million bbls of oil or 5.1 mb of oil per day. Since the majority of those vehicles (17Mil per year) are built and driven in America that 10-gallon average estimate is probably woefully low. This means not only will we have to raise global oil production from our current 85 mbpd to 91 mbpd simply to supply the additional gasoline but even higher to supply oil for all the other uses. OPEC currently estimates that demand will increase +1.7 mbpd in 2006. With China adding 7500 miles of interstate highways and 600,000 cars a month that estimate will be low for 2007 and after. If we are scrooges and increase annual demand by the same 2% OPEC expects it to increase in 2006 then demand in 2007 would be 88.4 mbpd, 2008 90.2 mbpd, 2009 92.0 mbpd and 2010 94 mbpd. Demand in 2010 would be nearly 9 mbpd over the current 85 mbpd rate. I believe that is understating it by several million barrels. Remember China grew demand by +8% last year and should continue to grow its pace of use very quickly. India will also accelerate its use of gasoline and oil products as it builds on its new found wealth as an outsourcing center.

The determinant factor here is simply supply. You can increase demand exponentially until hell freezes over but if you can't produce it in those quantities then the numbers are meaningless. What we will end up with is a price war. Competition for every available barrel/gallon. That price war will slow demand but it will continue to exceed supply every so slightly. Market factors will produce demand destruction due to price but that only makes all available oil even more valuable.

If gasoline demand did increase by 6 mbpd over the next five years it would mean that refining capacity would need to run at 110% to produce the needed fuel. Obviously you can't run at greater than 100% capacity in the reaal world. We simply do not have an extra 6 mbpd of capacity just lying around. That is the equivalent of 12 super size refineries at full capacity.

The winners in this scenario are the refiners because refining margins will widen as prices rise. Valero, Tesoro, Chevron, Exxon, Conoco, etc. On the production side the winners will be Conoco, who replaced their reserves used by +230% in 2005, is my all time favorite simply because of their aggressive stance. They currently control 9.4 billion bbls of proven reserves. Conoco produced 674 million bbls in 2005 but replaced that with 1.55 billion bbls of new reserves. Contrast that with the smaller companies like Marathon, which controls only 1.3 billion bbls. Exxon produced 917 million bbls in 2005 and replaced that by +112%. It means they only added 110 million bbls more than they produced or only 75 days worth of production.

This is why I am so focused on the energy sector. In a world of shrinking supplies those companies that are increasing reserves and increasing refining capacity will be the most profitable as time passes. There is no other investment vehicle that can produce the kind of returns I expect over the next ten years.

Stop losses, where applicable, will be left VERY loose due to the potential for oil to test $55-$58 range. If the stops are too wide for your risk profile please adjust them accordingly.


Natural Gas Chart - 60 min

Crude Oil futures Chart - Weekly

 


Changes in Portfolio

New Energy Plays

None


New Non-Energy Plays Dropped Plays
MTG $62.80 M.G.I.C. Investment Corp ** Stopped $65.25 **

New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

None today
 


Play Updates

Existing Plays

DO - $77.90 - Diamond Offshore Drilling ** Stop Loss $65 **

DO spiked up at the open on Tuesday allowing us to sell the short September call for an extra 40 cents at $4.90. We are set now with a stop loss on the call at $90 and a profit target at $68.

DO resumed its slight decline after oil prices weakened on Wednesday. This is a direct result of the RIG warning and while it is not positive for the LEAP it will let us lower our risk by buying back the short call for a smaller amount if $68 is reached. Support is at $75 and $72.

Company Info:

DO earnings were reported on the 9th and rose +767% to beat the street by +17 cents. Earnings for all of 2005 were $1.91 compared to a loss of -0.06 in 2004. Diamond predicted another great year in 2006.

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.

Position: 2007 $80 LEAP VCT-AP @ $10.00

Tuesday Feb-21st cost reduction strategy:
Sell the September $95 Call DO-IS @ $4.90
Set a stop loss on the call at DO $90
Buy back the call on a dip to $68.

Entry $75 (2/15)

RIG - $72.78 - Transocean Inc ** No stop **

RIG spiked at the open on Tuesday and allowed us to enter the Call/Put insurance combination for a net debit of only 10 cents. Can't complain about that! Our only problem is watching for RIG to stay under our stop on the call at $74.95 for three more weeks. Maintain the stop on the short call at $74.95 and the profit stop on the put at $57.

Company info:

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.

Position: 2007 $80 LEAP VOI-AP @ $9.00

Tuesday Feb-21st insurance strategy:
Sell the March $75 Call RIG-CO @ $1.90
Set a stop loss at $74.95
Buy the May $65 Put RIG-QM @ $2.00
Set a profit stop on the put at $57
Once we get a bounce in RIG we will sell calls to
reduce the cost.

Entry $75.00 (2/14)

GI - $66.19 - Giant Industries ** Stop Loss $46 **

Nice rebound by Giant, up +$10 from the Feb-14th lows under $58. The spike on Tuesday enabled us to get a lot more for the short June call. Maintain the stop loss at $73 but change the profit stop on the short call to $56.

Company info:

Giant Industries, Inc., through its subsidiary Giant Industries Arizona, Inc. and other subsidiaries, refines and sells petroleum products on the East Coast primarily in Virginia, Maryland, and North Carolina and in the Southwest primarily in New Mexico, Arizona, and Colorado, with a concentration in the Four Corners area where these states meet. Phoenix Fuel Co., Inc., another subsidiary, distributes commercial wholesale petroleum products primarily in Arizona. The Company has three business units: retail group, which operates service stations including convenience stores or kiosks; Phoenix Fuel, a commercial wholesale petroleum products distributor selling diesel fuel, gasoline, jet fuel, kerosene, motor oil, hydraulic oil, gear oil, cutting oil, grease and various chemicals and solvents, and refining group, which operates the Company's Ciniza and Bloomfield refineries in the Four Corners area of New Mexico and the Yorktown refinery in Virginia.

Position: Sept $65 Call GI-IM @ $8.50

Tuesday Feb-21st cost reduction strategy:
Sell the June $75 Call GI-FN @ $5.60
Set a stop loss on the call at $73
Set a profit stop on the call at $52, changed to $56 on 2/26

Entry $60 (2/14)

HP - $68.20 - Helmerich Payne ** Stop loss $55 **

That spike on Tuesday makes me wish I had sold the $75 call rather than the $70 call. Instead of a sharp downtrend we may have a rally on our hands. Maintain the stop on the June $70 call at $69.95 but change the profit target to $61.

Company info:

Earnings in January rose by +30% to $49 million compared to $17 million in the same quarter in 2004. It is all about day rates and HP commands some of the largest with their state of the art rigs. Unfortunately they were colored with the same brush as RIG on RIG's warning.

Helmerich & Payne, Inc. is primarily engaged in contract drilling of oil and gas wells for others. It is also engaged in the ownership, development and operation of commercial real estate. The Company is organized into two separate operating entities: contract drilling and real estate. The Company's contract drilling business is composed of three business segments: United States land drilling, United States offshore platform drilling and international drilling. The Company's United States land drilling is conducted primarily in Oklahoma, Texas, Wyoming, Colorado, and Louisiana, and offshore from platforms in the Gulf of Mexico and California. The Company also operated in seven international locations during the fiscal year ended September 30, 2005: Venezuela, Ecuador, Colombia, Argentina, Bolivia, Equatorial Guinea and Hungary. In addition, the Company is providing drilling consulting services for one customer in Russia. Its real estate investments are located in Tulsa, Oklahoma.

Position: Sept $75 Call HP-IO @ $7.20

Tuesday Feb-21st cost reduction strategy:
Sell the June $70 Call HP-FN @ $4.70
Set a stop loss on the call at $69.95
Set a profit stop on the call at $59, changed to $61 2/26

HP Entry $69 (2/13)

NOV - $63.76 - National Oilwell Varco ** Stop Loss $50 **

That spike on the Tuesday really helped our short call sale. Now we need NOV to linger under $68 for a few weeks to let us capture the bleed in premium. A brief dip back below $60 wouldn't hurt! Maintain the stop loss on the May $70 call at $69.95 and the profit stop on that call at $58.

Company Info:

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

Position: Aug $65 Call NOV-HM $6.90

Tuesday Feb-21st cost reduction strategy:
Sell the May $70 Call NOV-EN @ $4.20
Set a stop loss on the call at $69.95
Set a profit stop on the call at $58

NOV Entry $61.50 (2/14)

SUN - $78.07 - Sunoco ** Stop Loss $58 **

Outstanding! Up +$6 from our entry and we entered the insurance position for basically a breakeven. It does not get much better than this. All we need now is for oil prices to dip once more before the summer rally begins. Maintain the stop on the May $90 call at $89.95, with a profit stop at $70. Maintain the profit stop on the May $70 put at $66.

Original play description:

Sunoco has refining capacity of nearly 1 mbpd spread over five refineries and controls 4500 miles of pipeline and sells through 4528 retail outlets. They would make a very nice takeover target for Valero with a market cap of only $10.4 billion compared to $33 billion for Valero. Net income rose +61% in Q4 to $974 million. Valero made $1.35B for the same period.

Company Info:

Sunoco, Inc. operates through its subsidiaries as a petroleum refiner and marketer, and chemicals manufacturer with interests in logistics and coke making. Sunoco's petroleum refining and marketing operations include the manufacturing and marketing of a range of petroleum products, including fuels, lubricants and some petrochemicals. Sunoco's chemical operations consist of the manufacturing, distribution and marketing of commodity and intermediate petrochemicals. The Company's operations are organized into five business segments: refining and supply, retail marketing, chemicals, logistics and coke.

Position: 2007 $80 LEAP VUN-AP @ $8.70

Tuesday Feb-21st insurance strategy:
Sell the May $90 Call SUN-EA @ $2.95
Buy the May $70 Put SUN-QN @ $2.75
Set a stop loss on the call at $89.95.
Set a profit stop on the put at $65, changed to $66 2/26.
Set a profit stop on the call at $70.

Entry $72.51 (2/12)

COP - $62.77 - Conoco Phillips ** No Stop **

Conoco closed higher on Friday than its peers. Nice press on the +230% reserve replacement helped.

Play description:

Conoco continues to hover in the $58-$60 range. This should be support as the acquisition of Burlington Industries approaches. The companies expect it to conclude in the first half of 2006. Burlington reported earnings that nearly doubled the prior year in Q4 and Conoco reported earnings that rose more than +50%. Together they should receive some synergistic benefits and increase shareholder value. Conoco is the most aggressive integrated oil company when it comes to adding reserves. They are not afraid to pay for them and they are clearly planning for the future.

Company Info:

Conoco Phillips 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 Conoco Phillips 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.

Position: 2007 $65 LEAP OJP-AM @ $5.00

Insurance Put: May $55 PUT COP-QK only if COP trades at $57.50

Entry $60.00 (02/08)

SU - $76.86 - Suncor Energy ** Stop loss $55.00 **

Suncor spiked nearly +$4 at the open on Tuesday and gave us a winning insurance position even if it is only for March. Maintain the stop on the short March call at $79.95 and a profit stop at $70. Maintain a profit stop on the long put at $70 as well.

Play description:

Suncor is very active in the Canadian oil sands and has a strong plan to ramp production for the next decade. This is a very strong company in charge of their own fate. There are no OPEC concerns, no terrorists and no problems like Hugo Chavez. With the new government in Canada their business problems will likely ease instead of get worse.

I ate lunch with the Vice President of Suncore a couple months ago and he answered my questions very positively and with lots of confidence. I strongly believe this will be a good company for a long time. That does not mean profits cannot be hurt if we suddenly end up with an oil glut but that is not likely.

Company Info:

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.

Position: 2007 $85 LEAP OYX-AQ @ $10.40 2/06
Position: 2007 $85 LEAP OYX-AQ @ $7.70 on 2/13,
average cost $9.05

Tuesday Feb-21st insurance strategy:
Sell the March $80 Call SU-CP @ $2.65
Buy the March $70 Put SU-ON currently $0.85
Set a stop loss on the call at $79.95.
Set a profit stop on the put at $65, changed to $70 2/26.
Set a profit stop on the call at $68, changed to $70 2/26.

CCJ - $36.97 - Cameco ** No stop **

CCJ rebounded to $38.50 ($77 pre split) on Tuesday and then declined into the split at $37 on Thursday morning. Our target for a post split entry was the 2008 $40 LEAPS LTA-AH. Those should have been filled at $9 on Friday. The plan was to wait until a day after the split to allow premiums to settle. This will be a very long-term hold and I do not expect to be exiting this position in 2006. We will manage the cost by selling calls and taking out put insurance in hopes of getting our cost down to zero by year end.

CCJ has traded sideways around $37 since the split but I expect it to begin tracking higher once the post split depression eases. They are not making any more uranium and those that own it will continue to prosper. Put this in your portfolio and forget it.

Original Play Description:

We were triggered on the breakout at $72.50 on Monday and again on the $67 breakdown target on Wednesday. Each trigger was for a 1/2 position giving us a full position with an average cost of $9.80 each. That turned out to be the closing price on Friday so if you missed either opportunity you did not miss anything. We are going to add another full position after CCJ splits on Feb-23rd. I will email everyone with confirmation at that time.

This is my best single play in the list. Cameco just announced record earnings and raised their forecast for 2006 and beyond. They projected a +40% rise in revenue and a rise in margin from 23% to 28% for 2006. At the same time they announced a 2:1 split for Feb-23rd on the NYSE. They also raised the dividend to 32 cents from 24 cents payable on April 13th.

They also announced they were buying Zircatec for $108 million. Zircatec is a maker of nuclear fuel bundles for Canadian designed heavy water reactors. They said the acquisition would moderately boost 2006 earnings assuming no material changes in operations.

The combination of events including the purchase of Zircatec caused the stock to plunge from its all time high of $82.15 on Feb-1st to close at $69.97 on Friday Feb-3rd. That level remained support for the entire week through Feb-10th.

2:1 Split scheduled for Feb-23rd

Plan on doubling up with some $40 2008 LEAPS once the split occurs.

Company Info:

Cameco Corporation is engaged in exploring, developing, mining and milling uranium ore to produce uranium concentrates. The Company is also a commercial converter of uranium concentrates (U3O8) to UF6 (uranium hexafluoride), as well as a supplier of services to convert uranium concentrates to UO2 (uranium dioxide). Cameco, through its subsidiaries, has a 31.6% limited partnership interest in Bruce Power Limited Partnership, which operates six nuclear reactors in Ontario, Canada. Cameco also owns 53% of Centerra Gold Inc. (TSX: CG), a growth-oriented gold mining and exploration company engaged in the acquisition, exploration, development and operation of gold properties in Central Asia, the former Soviet Union and other emerging markets.

Pre-split entries:
Breakout target $72.50
Position: 2007 $80 LEAP ZBK-AP 1/2 position @ $10.60 (2/06)

Breakdown target $67.00
Position: 2007 $80 LEAP ZBK-AP 1/2 position @ $9.00 (2/08)

Pre-split average cost: $9.80
Post split position: (4) 2007 $40 LEAP ZBK-AH @ $4.90

Additional Position: 2008 $40 LEAP LTA-AH @ $9.00 on 2/25.
Added after the 2:1 split on 2/24

Put insurance: None today

HAL - $71.21 - Halliburton ** No Stop **

Halliburton appears to be trying to form a bottom in the $70 range but somebody is still sitting on the ask at $72. I don't want to add any new positions for insurance until after the split in three weeks.

Play description:

Halliburton is planning on spinning off KBR, its construction and engineering unit. This should produce a significant bounce in HAL stock. (KBR stands for Kellogg, Brown and Root) HAL is a very strong service company and should soar when it is no longer held in check by the sins of KBR.

2:1 Split scheduled for March 23rd.

Company Info:

Halliburton Company is an oilfield services company, and a provider of engineering and construction services. The Company provides services, products, maintenance, engineering and construction to energy, industrial and governmental customers. Its six business segments are Production Optimization, Fluid Systems, Drilling and Formation Evaluation, Digital and Consulting Solutions, collectively the Energy Services Group, and Government and Infrastructure, and Energy and Chemicals, collectively known as KBR. In August 2004, the Company sold its surface well testing and sub-sea test tree operations to Power Well Service Holdings, LLC. In January 2005, the Company emerged out of the chapter 11 proceedings and can operate the businesses without Bankruptcy Court supervision.

Position: 2007 $85 LEAP Call VHW-AQ @ $9.80

Insurance Put: None until after the split

Entry $79.00 (2/06)

KMG - $100.33 - Kerr Mcgee ** Stop Loss $78.00 **

Nice bounce on KMG allowed us to get insurance at the right price. Maintain a stop loss on the short April $105 call at $104.95 and a profit stop at $93. Maintain a profit stop on the put at $85.

Company Info:

Kerr-McGee Corporation (Kerr-McGee) is an energy and inorganic chemical holding company whose consolidated subsidiaries, joint ventures and other affiliates (together, affiliates) have operations throughout the world. The Company's core businesses include exploration and production, and chemicals. Kerr-McGee's oil and gas exploration and production areas are onshore in the United States, in the Gulf of Mexico, the United Kingdom sector of the North Sea and China. In addition, the Company has exploration programs in Alaska, Brazil, Morocco, Bahamas and Benin. Kerr-McGee affiliates engaged in chemical businesses produce and market inorganic industrial chemicals, lithium-metal-polymer batteries and heavy minerals. On June 25, 2004, the Company completed a merger with Westport Resources Corporation. On March 8, 2005, the Company annonced its decision to proceed with the proposal to pursue alternatives for the separation of the chemical business, including a spinoff or sale.

Position: 2007 $115 LEAP Call OGM-AC @ $9.00

Tuesday Feb-21st insurance strategy:
Sell the April $105 Call KMG-DA @ $3.00
Buy the April $90 Put KMG-PR @ $1.25
Set a stop loss on the call at $104.95.
Set a profit stop on the call at $93.
Set a profit stop on the put at $85.

Entry $107.00 (2/06)

UPL - $55.35 - Ultra Petroleum ** Stop Loss $45.00 **

Outstanding bounce on UPL allowed us to get insurance close to the current price at a basic breakeven on cost. Maintain the stop loss on the short June $65 call at $64.95 and a profit stop on the call at $50. Maintain a profit stop on the June $55 put at $50 as well.

Gas prices are going down and I fully expect to exit the insurance at $50 for a nice profit and a reduction in the cost of our LEAP.

Original play description:

Ultra was one of the few that did not get hit on Monday. The breakdown target at $62 was our trigger on Tuesday but unfortunately it was followed by a -$7 drop on Thursday. They announced earnings on Tuesday that beat the street but they were hammered on Thursday after announcing they entered into a pipeline agreement with Rockies Express Pipeline (REP) for $70 million a year for ten years starting in 2007. REP is obligated to build pipelines to southwestern Wyoming and transport 200,000 MMBtu per day of gas to connecting hubs for Ultra.

Ultra's finding and development cost for 2005 was $0.56 per MCFe and reserve replacement was 773%, both the best in the industry. Ultra has 17 years of drilling planned with 160 wells planned for 2006 in Wyoming alone. They produced 73.4 Bcfe of gas in 2005 which suggests the 200,000 MMBtu capacity being contracted above is only a portion of their expected Wyoming production. With Wyoming gas selling for more than $8 per MMBtu in January that represents $1.6 million in gas production through the pipeline per day or roughly $584 million per year. I would gladly pay $70 million for pipes to carry $584 million of gas to market.

Ultra ended 2005 with no debt. Their profit per MCFe was $6.94 in Q4. Net profit increased +111% in 2005, ROE was 55%. Proved reserves in Wyoming at the end of 2005 were 2.022 TCFe of gas, a +32% increase over 2004. Proved and probable reserves were 6.29 TCFe. This represents better than a 2000% increase in reserve growth since 1999. Ultra has more than 2877 scheduled wells to drill in Wyoming over the next 17 years.

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.

Position: 2007 $70 LEAP Call OZH-AN @ $10.70

Tuesday Feb-21st insurance strategy:
Sell the June $65 Call UPL-FM @ $4.30
Buy the June $55 Put UPL-RK @ $4.30
Set a stop loss on the call at $64.95.
Set a profit stop on the put at $50.
Set a profit stop on the call at $50.

Entry $62 (2/08)

MTG - $64.34 - M.G.I.C. Investment Corp ** Stopped $65.25 **

Stopped out by 7 cents on 2/22 on no news and three times normal volume. MGIC just authorized a new 10 million share buyback so it could have been them supporting their stock price. $1.80 profit on the position so no harm here.

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.

Positon: 2008 $65 LEAP Put YHM-MM @ $6.50, exit 8.30, +1.80, 2/22
(No 2007 $65 put exists)

Insurance Call: None

Entry $67.22 (01/15)

VLO - $56.22 Valero ** No Stop **

No change in UPL other than the continuation of the nice bounce from $48 to $56. The cost in our LEAP is only $1.60 so we can put this one on the back burner and forget it.

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.

Position: 2007 $60 LEAP Call VHB-AL @ $6.60
1/30 Cost reduced by spread on put/call -0.90, now $5.70
2/06 Cost reduced by -1.00 on closed call, now $4.70
2/09 Cost reduced by -3.10 on closed $57 put, now $1.60

Monday Feb-13th
Set profit stop on March $45 put at $48 on VLO

Insurance Put: March $45 Put VLO-OI @ $1.20 ** Still open **
Put entered on 12/27 when VLO traded at $51

Monday Feb-6th:

Close the March $65 Call VLO-CM @ $1.50, +1.00
Set a profit target on the March $57 put at $54, exit $4.70 (2/9)

Monday Jan-30th:

Sell March $65 Call VLO-CM @ $2.50 bid
Buy March $57.50 Put VLO-OY @ $1.60 ask
Set a stop loss on the call at $64. Profit stop at $54
Set a profit stop on the put at $52.

Entry $52.30 (12/16)

HW - $37.46 - Headwaters ** No Stop **

No change in the play. Maintain the stop loss on the call at $39.95.

********

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.

Position: 2007 $40 LEAP Call ZPP-AH @ $4.30

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

Entry $35.50 (11/22)

CHK - $29.99 Chesapeake Energy ** No Stop **

CHK bounced nicely with the sector but lower gas prices are coming. The spike on Tuesday allowed us to get more for our short call but it was still just a token amount. Maintain the stop loss on the April $32.50 call at $32.50 and maintain a profit stop at $28.

There was no insider trading over the last week. Evidently the insiders are still waiting for he spring demand drop for gas.

Meanwhile target $25 to sell the existing put.

Prior commentary:
The CEO said on Wednesday (2/01) that CHK is more likely a buyer of other companies and assets than a target of a takeover itself. He said there were many potential targets smaller than Chesapeake and the drop in gas prices made them attractive. He said gas prices should remain in the $7.50-$10.50 range the rest of the year. He did not expect any major to make a big play like Conoco did when it purchased Burlington late last year for $35 billion. He also said CHK's $2.2 billion acquisition of Columbia Natural Resources was going better than planned and the opportunity appears to be bigger than originally thought. McClendon said CHK had actively hedged its output when prices were higher and were profiting from the swings in prices. He said the plunge in gas prices was "fantastic" because it made acquisitions cheaper, stemmed demand destruction and gave consumers a break on their utility bills. CHK also announced the private placement of $500 million in 6.5% notes due in 2017. The proceeds would be used to pay off bank debt. What a deal! Gas will be $30 by then and the $500 million plus interest will be chump change.

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.

Position: 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:
Sold the April $35 Call CHK-DG currently $2.15
Set a stop loss on the call at $34.95, exit @ $2.70, -55, 1/30

Tuesday Feb-21st cost reduction strategy:
Sell the April $32.50 Call CHK-DZ @ $1.40
Set a stop loss on the call at $32.50.
Set a profit stop on the call at $27, change to $28 on 2/26.

Entry $29 (11/04)

 


Leaps Trader Watch List

Keeping It Loaded

I am adding only three plays this week but I am not taking any off. This should continue to give us some added possibilities on any future dips. I am not hoping for another return to $58 oil but if it comes we will be ready.

I am adding a new split play, CNI, which splits 2:1 on the 28th. I want to buy longest options available the day after the split.

Jim Brown
 

Dropped Entries

None


New Watch List Entries
CNI
$93.17
Canadian National Railway
RAIL $69.79 FreightCar America
TIE $42.00 Titanium Metals

Current Watch List

TS - $160.40 - Tenaris

The potential for a 3600-mile gas pipeline sent TS soaring even though they are not in the business of making 52 inch tube.

Tenaris S.A. is a global manufacturer of seamless steel pipes for the oil and gas industry and a global supplier of seamless steel pipes for process and power plants and for industrial and automotive applications. It is also a regional supplier of welded steel pipes for oil and gas pipelines in South America. Tenaris focus on providing end-user customers a service that integrates manufacturing, procurement, distribution and on-time delivery of products throughout the world. Incorporated in Luxembourg, the Company has manufacturing facilities in Argentina, Brazil, Canada, Italy, Japan, Mexico, Romania and Venezuela. It also has a proprietary global service and distribution network in over 20 countries. Tenaris' customers include many of the world's major oil and gas companies, as well as a large number of engineering and industrial companies.

Breakdown target $145.00
Buy Sept $170 Call TSW-IN 1/2 position

This is a wild card shot. If we do get the drop I would love to buy the option but the options are expensive!

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

PBR - $91.50 - Petro Brasileiro

Petroleo Brasileiro S.A. - Petrobras (Petrobras) is a mixed-capital enterprise of which a majority of voting capital must be owned by the Brazilian Government. The Company is engaged in a range of oil and gas activities, which include segments such as exploration and production, refining, transportation and marketing, distribution, natural gas and power, international, and corporate. Besides the dominant market position in Brazil, Petrobras has oil and gas activities in international locations, with significant international operations in Latin America, the Gulf of Mexico and West of Africa. 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 $84.00
Buy 2007 $90 LEAP Call VDW-AR

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

SLB - $118.39 - Schlumberger Ltd.

2:1 Split April 7th

Schlumberger Limited (Schlumberger) is an oilfield services company that supplies technology, project management and information solutions for the oil and gas industry. Schlumberger consists of two business segments: Schlumberger Oilfield Services and WesternGeco. Schlumberger Oilfield Services is an oilfield services company that supplies a range of technology services and solutions to the international petroleum industry. WesternGeco, jointly owned with Baker Hughes, is a surface seismic company. On January 29, 2004, Schlumberger completed the sale of its SchlumbergerSema business to Atos Origin. During the year ended December 31, 2004, Schlumberger completed the initial public offering of Axalto and no longer retains any ownership interest in this business.

Breakdown target $111.00
Buy 2007 $120 LEAP Call VWY-AD

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

BTU - $50.75 - Peabody Energy

2:1 Split 2/23

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 $46.00
Buy 2007 $55 LEAP Call ZZT-AK

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

PCU - $81.50 - Southern Copper Corp

Southern Copper Corporation, formerly Southern Peru Copper Corporation (SPCC), is an integrated producer of copper that operates mining, smelting and refining facilities in the southern part of Peru. The copper operations of the Company involve mining, milling and flotation of copper ore to produce copper concentrates, the smelting of copper concentrates to produce blister copper and the refining of blister copper to produce copper cathodes. SPCC also produces refined copper using the solvent extraction/electrowinning (SX/EW) technology. Silver, molybdenum and small amounts of other metals are contained in copper ore as by-products. Silver sold is recovered in the refining process or as an element of blister copper. Molybdenum is recovered from copper concentrate in a molybdenum by-product plant.

Breakdown target $75.00
Buy Sept $85 Call PCU-IQ

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

HOC - $60.55 - Holly Corp

Holly is a very strong company despite its small size. It has a huge cash pile and no debt. The ratio of cash to equity is currently 67% and Holly is trading at only a 9 PE. The $2B company is a huge takeover target given its inland refineries and pipeline capacity. Forbes named it one of America's best managed companies with a five year annualized return of 80.7%, the best in the oil and gas industry.

Holly Corporation (Holly) is an independent petroleum refiner that produces and distributes high-value light products, such as gasoline, diesel fuel and jet fuel. As of December 31, 2004, the Company, through its principal subsidiaries, operated and managed three refineries located in Artesia and Lovington, New Mexico (operated as one refinery); Woods Cross, Utah (Woods Cross refinery), and Great Falls, Montana (Montana Refinery). Holly also holds ownership interests in Holly Energy Partners, L.P. (HEP), a limited-liability company that owns and operates pipeline and terminally ailing assets, as well as 70% interest in the Rio Grande Pipeline Company (Rio Grande). Rio Grande owns a 249-mile pipeline that transports liquid petroleum gases (LPGs) from West Texas to the Texas/Mexico border. During the year ended December 31, 2004, gasoline, diesel fuel and jet fuel (excluding volumes purchased for resale) represented 59%, 26% and 5%, respectively, of the refinery's sales volumes.

Breakdown target $56.00
Sept $65 Call HOC-IM

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

OIH - $139.91 - Oil Service Holders (LEAP PUT SALE)

The Oil Service HOLDRS Trust issues depositary receipts called Oil Service HOLDRS, representing an undivided beneficial ownership in the common stock of a group of specified companies that, among other things, provide drilling, well-site management, and related products and services for the oil service industry. The Bank of New York is the trustee. The Oil Service HOLDRS Trust was formed under a depositary trust agreement dated February 6, 2001. The 18 issuers of the underlying securities represented by Oil Service HOLDRS, as of August 1, 2005, were Baker Hughes Incorporated, BJ Services Company, Cooper Cameron Corporation, Diamond Offshore Drilling, Inc., ENSCO International Incorporated, Grant Prideco, Inc., GlobalSantaFe Corp., Halliburton Company, Hanover Compressor Company, Nabors Industries Ltd, Noble Corporation, National Oilwell Varco Inc., Rowan Companies, Inc., Transocean Inc., Smith International, Inc., Schlumberger Limited, Tidewater Inc. and Weatherford International Ltd.

Breakdown target $135.00
SELL 2007 $160 LEAP PUT ZJO-ML
BUY April $120 Put OIH-PD

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

XLE - $53.63 - Energy Select SPDR

The Energy Select Sector SPDR Fund (the Fund) is an index fund that seeks to replicate the total return of the Energy Select Sector Index of the Standard & Poor's 500 Composite Stock Index (S&P 500 Index). During the fiscal year ended September 30, 2004 (fiscal 2004), the Fund had a return of 48.27%, as compared to the Energy Select Sector Index return of 48.91% and the S&P 500 Index return of 13.87%. The Fund invests in industries, such as energy equipment and services, and oil and gas services, among others. In fiscal 2004, its top five holdings were Exxon Mobil Corp., ChevronTexaco Corp., ConocoPhillips Inc., Schlumberger Ltd. and Occidental Petroleum Corp.

Breakdown target $50.00
BUY 2007 $55 LEAP Call OJW-AC

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

CNI - $93.17 Canadian National Railway

Canadian National Railway Company (CN), directly and through its subsidiaries, is engaged in the rail and related transportation business. As of December 31, 2005, the Company had a network of approximately 19,200 route miles of track. CN's network spans Canada and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of Vancouver, Prince Rupert, British Columbia, Montreal, Halifax, New Orleans and Mobile, Alabama, and the cities of Toronto, Buffalo, Chicago, Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with connections to all points in North America. The Company's revenues are derived from the movement of seven commodity groups, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, intermodal and automotive.

Currently the longest option you can buy is the October series. I am hoping that after the split they will add something farther out. Buy the longest dated option available the day after the split. I will email an update when it happens.

Breakdown target: No price. Buy the $50 calls for October or farther if available.

BUY $50 Call CNI-JJ should be the symbol for October

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

RAIL - $69.79 FreightCar America

FreightCar America, Inc. is a manufacturer of aluminum-bodied railroad freight cars (railcars) in North America. The Company specializes in the production of coal-carrying railcars, which represented 78% of its deliveries of railcars, during the year ended December 31, 2004, while the balance of its production consisted of a broad spectrum of railcar types, including aluminum-bodied and steel-bodied railcars. It also refurbishes and rebuilds railcars and sells forged, cast and fabricated parts for all of the railcars that the Company produces, as well as those manufactured by others. Prior to April 1, 2005, the Company was named FCA Acquisition Corp. On April 1, 2005, a former parent company, also named FreightCar America, Inc., merged with and into FCA Acquisition Corp., with FCA Acquisition Corp. being the surviving corporation. In connection with the merger, FCA Acquisition Corp. changed its name to FreightCar America, Inc.


Currently the longest option you can buy is the September series.

Breakdown target: $66.

BUY Sept $70 Call RQN-IN

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

TIE - $42.00 Titanium Metals

2:1 Split 2/17

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.


Currently the longest option you can buy is the September series.

Breakdown target: $38.

BUY Sept $45 Call TIE-II
 


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