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Weekly Newsletter, Saturday, 08/05/2006

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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

Even Experts Fail

The headlines carried the news almost in disbelief. Bo Collins energy hedgefund is closing because of large losses. Bo Collins was the past president of the Nymex and should have understood the risks. He hired the best traders and at one time managed over $420 million in energy investments. The fund, MotherRock, announced this week it was closing after suffering $220 million in losses in June and July. Makes our losses seem rather tame.

It shows that even the best of minds and experts can sometimes make bad bets when they refuse to ignore the facts in favor of their biases. MotherRock believed in natural gas. They were long an obscene amount expecting the price to rebound higher after the collapse from the April highs. Unfortunately the first six months of 2006 were the warmest on record. Natural gas demand evaporated without strong demand to heat homes and businesses. The fundamentals of gas never changed. The uncertainty of seasonal weather patterns simply postponed the inevitable. Prices will go higher but only when normal seasonal weather patterns return. Betting tens of millions on short-term fluctuations is suicide if Mother Nature is not on your side. Ironically two analysts appeared on CNBC late Friday suggesting natural gas was the best bet for the future given its decline and long-term fundamentals. I am sure Mr. Collins will back into his kicking machine every time gas ticks back over $10 for as long as he lives. He disobeyed the rule every trader should live by. The market can always remain contrary to your bias longer than you can remain liquid. Millions of traders have folded trades after watching them plunge into ruin long after they should have been closed only to see the position reverse immediately after they exited.

It may be time to start bailing on oil positions because the number of analysts now predicting $80 oil and higher is growing every day. This is a sure sign of a bubble that needs popping. Once everyone goes long there can be no further gains because there is nobody left to take the other side of the trade. Without shorts thinking we longs are crazy there is nobody being forced to cover.

The analysts have good reasons to expect higher oil prices in the future because we have seen almost daily some new evidence of a problem. Last week Mexico announced the Canatrell oil field was in steeper decline than previously expected. This is the second largest field in the world and second only to Ghawar in Saudi Arabia. Production from the field has declined -15% in the last two years, -10% in the last five months. This is a problem for us because 88% of all Mexican oil exports come to the US. 8% of our total oil consumption comes from Mexico. Mexico was the 5th largest exporter in the world but declines in their fields and increased internal consumption will rob them of that place very soon. Our top three importers are Canada, Mexico and Saudi Arabia in that order. Mexico produced 3.42 mbpd in early 2005. 2.1 mbpd came from Canatrell. That production has fallen to only 1.74 mbpd and is slipping fast losing -10% in just the last five months. According to an official quoted in the Wall Street Journal, Canatrell production could drop -75% by the end of 2008.

I have preached the depletion problem long and hard over the last two years and nobody wanted to listen. This is a perfect example in our own backyard. Once a field goes into decline there is no recovery. The faster that field was produced the faster it will decline. It is a geological fact and no amount of posturing will make it not so. As fields reach their output peak those in charge of producing will begin to resort to more extreme measures to maintain that peak. Gas injection, water injection, additional wells, additional types of wells like horizontal drilling, workover wells, down hole pumps, etc. All these methods are fine and accepted the world over but they only delay the inevitable and at great cost. If a field has one billion bbls of recoverable oil you can only extract 50% before the field begins to decline, sometimes less depending on the geology and oil type. The last 50% will always come out slower and at higher cost than the first 50%. Each percent over 50 will be harder to extract than the one before it. It is a fact of life and like gravity it cannot be changed.

Hastening the depletion problem is a lack of investment in additional infrastructure and the latest technologies. Mexico is a poor country and oil facilities are old and inefficient. Without tens of billions of dollars in new investment this depletion curve will accelerate. The historical depletion rate for an average field is a -4% decline in production per year once the peak has passed. Some much faster and some much slower but they all decline. This is why new global production cannon be added fast enough to prevent Peak Oil. Currently global production is around 85 mbpd. Many of those fields are more than 50 years old. Using the -4% average depletion rate that means we have to add 3.4 mbpd of new production each year just to stay even while demand continues to grow. It is a technical impossibility to beat the depletion clock forever. Experts theorize that 2.2 trillion bbls of recoverable oil exist on the planet. We have already produced and consumed half of that. Much of the remainder has yet to be found because it lies in places that will be very hard to recover once found. The easy fruit has already been picked.

Adding to the problem was an admission from Kuwait this week that they were going to revise down their reserve estimates. No big deal, right? Wrong! For the last two decades Kuwait has been claiming reserves of 100 billion bbls. All the OPEC members raised their reserve estimates by as much as 100% when OPEC went on the quota system. The more oil you claimed you had the larger your quota and the more you could sell. Each country also raised its claimed reserves to preserve their bragging rights. OPEC is a very close-knit club and claimed reserves determines your stature in that club.

Kuwait said they were considering lowering their proven reserves to 25 billion bbls plus another 25 bil-bbls of unproven or probable reserves. Those are reserves yet undiscovered or requiring future technology to produce. The result of their 50% haircut is a sharp drop in the claimed reserves for OPEC and the number used by the IEA and EIA to project future production. Everyone outside of OPEC has known the emperor, Saudi Arabia, and his kids, the other OPEC nations, had no clothes. In other words they were overstating their reserves by as much as 100%. Kuwait stepped into the light and admitted this problem. Eventually the other OPEC nations will be forced to do the same. If you cannot produce more oil this year than you did last year then your veracity will eventually be questioned and the truth will eventually come out.

Saudi Arabia could be the next confessor. Since they claim more reserves than anyone else, 262 billion bbls, they have the hardest case to prove. If you are sitting on an ocean of oil then why has your production slowed substantially over the years to its current 9.2 mbpd estimate from the nearly 12 mbpd in the past? Saudi claims it could produce 15 mbpd in the near future and keep it up for 50 years. Saudi currently has a record 100 drilling rigs in operation compared to the dozen it maintained for decades. Saudi claims it is spending $100 billion in an effort to raise production to 12.9 mbpd by 2010. The problem according to the EIA is the 5-12% decline rate in its existing fields. This was based on a recent revelation by Aramco Senior Vice President Abdullah Saif, as reported in Petroleum Intelligence Weekly and the International Oil Daily. This means the country needs to add between 500,000-1 million bpd in new capacity each year just to maintain current levels. According to Saif, the average total depletion for Saudi fields is 28% with Ghawar at 48%. Many experts believe the depletion rate is much more severe. Saudi has been injecting water and natural gas into its fields for years to maintain pressure and according to experts the water cut in some fields is reaching unusable proportions. In other words the proportion of water to oil in the production output has reached a level where it is not worth the effort. Saudi also announced last week it was now injecting steam into some of its fields to increase the flow of stubborn deposits. Steam production of that magnitude requires monster amounts of natural gas. Gas is in short supply in Saudi due to a rapid build growth of electrical demand from buildings and homes using air conditioning modern appliances and electronics. They would not be burning gas to create massive amounts of steam if they have 262 billion bbls of oil just waiting to be pumped?

Getting behind the depletion curve is an often fatal event. By not investing in infrastructure and advanced drilling and production methods the depletion event will occur sooner rather than later. Once it begins to occur without additional accelerated recovery methods it is many times impossible to return to prior production levels. Once the curve accelerates the availability of funds to increase production is normally a problem. Declining production produces declining income and normally that income is already allocated to other areas. This is especially true in the case of countries like Russia and Venezuela. Once you have driven out the third party oil companies by imposing horrendous taxes or confiscating assets there is no incentive for them to return. Money is spent on social programs to remain in power rather than increasing production. It is a death spiral for the industry and one that can rarely be reversed. Both Russia and Venezuela are experiencing production declines and there is no outside investment to remedy the problem. Venezuela announced that it was no longer going to sell gasoline to 1800 Citgo stations in the US because it was not profitable. Actually it was because they could not produce enough oil to keep them supplied. They also had to commit to buy 100,000 bpd from Russia to meet prior commitments overseas.

I know this rant took on a life of its own this weekend but once I get on my soap box it is hard to quit. I am constantly amazed by how many "experts" fail to do even the most basic analysis before making fools of themselves. I am also amazed by how numbers from the IEA and EIA tend to be accepted as gospel by the press when their estimates are so laughable to those inside the energy community. I just keep this phrase on my desktop, "Those who laugh last laugh loudest."

Tropical storm Chris was demoted on Friday to a tropical depression but it is still headed straight for the oil patch. Oil prices fell on the downgrade but once Chris leaves the Caribbean and its various landmasses and hits the open warm water of the Gulf it could quickly gain strength and become a problem again. Don't ignore Chris until it makes permanent landfall in the US.

NOAA Storm Path

Gasoline Demand Chart

Oil prices may have faded into the weekend but remain centered around $75. This is the neutral zone for oil as we await a resolution in the Middle East, resumption of shipments from Nigeria and Chris. Gasoline demand continues to be strong at 9.639 mb for the week ended 7/28. This was slightly higher than the 9.586 mb from the same week in 2005. This is even more amazing since the price of gasoline is well over $3 across the US. I paid $3.09 for regular in Colorado this week. I know those on the West Coast would kill to get that price but it was the most I ever paid in a non hurricane environment. This is keeping the crack spreads high and refiners like Valero should be printing money. According to one analyst the crack spread last week hit 56 cents per gallon. That is about 250% of normal for this time of year. The problem is refinery utilization, which has fallen to 90.8%. Several refineries are running well below capacity due to problems and the huge outage at the Venezuelan refinery, which is expected to continue for a long time. Crude oil inventories were down -1.8mb this week and gasoline inventories were down -162,000 bbls. With refinery utilization rates so low gasoline imports are rising but the VZ refinery problem is raising the demand and price on the global market. If Chris did develop into a hurricane and its present course did not change it would probably hit the Texas refinery complex and/or the Louisiana complex as well. This could further crimp output and push gasoline prices higher.

Crude oil imports fell by -76,000 bpd last week and domestic production fell -201,000 bpd to 4.94 mbpd. Last August oil production was 5.427 mbpd.

Natural gas spiked to $8.55 on Wednesday due to very hot weather and increased demand. After the gas inventory report showed a +19bcf injection last week prices eased to close at $7.24 on Friday. The prior week saw an unprecedented -7bcf withdrawal from storage rather than a gain. The week was 21% hotter than normal based on heating degree-days. The spike in gas prices from the $5.63 low on July 18th to the $8.55 high on Aug-2nd is an extreme abnormality. That was a +52% jump in price in only three weeks. I sure wish I had been long gas futures! It is no wonder MotherRock is getting out of the nat gas betting business with volatility like that.

The hot weather sent coal stocks soaring along with gas prices and we recovered a lot of ground in our coal plays. If the hot weather continues I would expect them to continue higher.

I considered selling some calls at this level but with the potential for a hurricane disruption I elected to pass. Until Chris hits the Gulf we need to hold off. If Chris evaporates I will send an update with any strategy changes. Fortunately with hurricanes we can see them coming a long way off and can react to manage any short call positions.

I am still expecting a decline in oil prices as the summer draws to a close but geopolitical conditions are providing support. Keep the faith and we will play the cards we are dealt. With earnings over for the majority of energy stocks there is little to provide motive power other than Chris.


September Crude Futures - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas 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 this week.
 


Play Updates

Existing Plays

OIX - $642.30 - Oil Index Portfolio Hedge

No Change in play. The OIX is resting on support at 640 and should Chris evaporate I believe oil prices will as well. I would continue to enter the OIX hedge but probably use a higher strike than the initial Sept-550 put.

Current recommendation: Buy above $600

Play description:

The CBOE Oil Index consists of 11 energy stocks of primarily integrated oils. The index reacts sharply to changes in the price of oil and gas.

The focus of this play is to hedge our current energy positions against a decline in oil prices as the summer draws to a close. Each reader will have to decide how many contracts needed to hedge their current positions. You do not want to be moving in and out of the OIX position given the relatively wide bid/ask spread.

A drop to $540 should double the premium paid and a drop to $500 should produce a $50 premium or $5000 per contract. At our entry price of $12.00 or $1200 that represents $3800 profit per contract. That would hedge several of our current positions very easily.

Index Components:

Position:

Sept $550 Put OIX-UJ @ $12.00, no stop.

BHI - $77.83 - Baker Hughes Intl ** stop loss $75 **

BHI continues to trade in a range and could see some weakness on a drop in gas prices. I am still positive about BHI and would buy them on weakness for a long term hold but I did raise the stop loss.

With our cost now at $2.60 we will not add any new insurance puts. We could end up doubling our cost without any real benefit. We will take the stop at $73 it touched.

Current recommendation: Hold

Earnings: July 28th, EPS $4.14, $1.4 billion

Company info:

Baker Hughes Incorporated (Baker Hughes) is engaged in the oilfield services industry. The Company supplies wellbore-related products and technology services and systems to the oil and natural gas industry on a worldwide basis, including products and services for drilling, formation evaluation, completion and production of oil and natural gas wells. Baker Hughes operates through subsidiaries, affiliates, ventures and alliances. It operates in three business segments: Drilling and Evaluation, Completion and Production, and WesternGeco. The Drilling and Evaluation segment consists of the Baker Hughes Drilling Fluids, Hughes Christensen, INTEQ and Baker Atlas divisions. The Completion and Production segment consists of the Baker Oil Tools, Baker Petrolite and Centrilift divisions. The WesternGeco segment consists of the Company's 30% equity interest in WesternGeco, a seismic venture with Schlumberger Limited. WesternGeco provides reservoir imaging, monitoring and development services.


Position: Jan $95 Call BHI-AS @ $6.20
Cost update: Closed short $100 Call, +0.90, cost = $5.30
Cost update: Closed long $80 Put, +2.70, cost = $2.60


Additions 6/08 (closed 6/13)
Short: Jan $100 Call BHI-AT, entry $3.20, exit $2.30, +0.90
Long: Jul $80 Put BHI-SP, entry $4.30, exit $7.00, +2.70


Entry $85.24 (6/6)

ACI - $37.87 - Arch Coal Inc ** Stop $30.00 **

Arch sprinted higher with the surge in natural gas giving us an opportunity to add an insurance put for the rest of the summer. Buy the Sept $35. ACI bought one-third interest in Knight Hawk Coal for $15 million in cash and 30 million tons of coal. Arch said it was a meaningful deal that would be accretive immediately. The next support level is just over $30.

New recommendation: Insurance Put
Buy Sept $35 Put ACI-UG currently $1.50

Current Recommendation: Buy under $35

Earnings: July 21st, $69.6 million, $0.48 cents

Prior Commentary:

The CEO said in an interview on June 28th that a lot of legacy contracts were expiring soon and that had great implications for their bottom line. Arch saw profits jump 10-fold in the first quarter as new contracts took effect. He said coal would be so short that users would want to secure future contracts to guarantee supply. Coal prices have risen sharply since 2004 doubling in most US basins and tripling in some. Because Arch sells its coal under long-term contracts it has yet to see these prices. Customers of Arch had been locked in at 2003 prices. He said over the next three years the vast majority of their contracts would expire. He said Arch would be selective on which they would renew at current prices. With a strong balance sheet they can take a different view of sales. He said it was the best environment seen in over 20 years for coal. The US currently has 310 gigawatts of electric power and 50% is fired by coal. The US is adding 90 gigawatts with 20 GW being completed by 2010. This will consume another 65 million tons of coal or an increase of roughly 6.5% over current production not counting increases in other areas.

Company Info:

Arch Coal, Inc. operates as a coal producer in the United States. The Company's primary business is the production of steam and metallurgical coal from surface and underground mines throughout the United States, for sale to utility, industrial and export markets. Its mines are located in southern West Virginia, eastern Kentucky, Virginia, southern Wyoming, Colorado and Utah. As of December 31, 2005, it operated 21 mines, and controlled approximately 3.1 billion tons of proven and probable coal reserves. During the year ended December 31, 2005, the Company sold approximately 140.2 million tons of coal. The Company has three business segments, which are based on the low-sulfur coal producing regions in the United States, in which the Company has operations. These segments are the Central Appalachia region, the Powder River Basin and the Western Bituminous region. On December 31, 2005, the Company sold its 100% interest in Hobet Mining, Inc., Apogee Coal Company and Catenary Coal Company.


Position: Jan 2008 $50 LEAP Call YEP-AJ @ $4.20

New recommendation: Insurance Put 8/06
Buy Sept $35 Put ACI-UG currently $1.50

Entry $48.36 (5/31)

TIE - $28.49 - Titanium Metals ** Stop Loss $25.00 **

No change in play. TIE is holding over $28 on good press. If it does break I have added a new stop loss.

Billionaire Harold Simmons, Chairman of TIE, bought 275,000 shares last month at an average price of just over $26. He has bought $53.6 million in TIE stock over the last 18 months. His last purchase was May 18th for 200,000 shares at $34.88. He now owns 59.8% of TIE stock. If he is buying at $26 maybe we need to double down here.


Current Recommendation: Hold

Earnings: July 24th, +64%, $54.3M, 0.31 cents

Prior commentary:

Analyst Chris Olin of FTN Midwest Securities said this week that demand for TIE products will continue to surge through 2012. TIE is already at 88% capacity and has a backlog of $860 million in orders. Despite additional capacity plans by both TIE and ATI the market is expected to be undersupplied through at least 2010. Chairman Harold Simmons personally owned 2.6% of TIE shares as of March 31st but a holding company he controls owns 37.1% and SEC documents show that he and the company are aggressively increasing their positions. Boeing has orders for 393 of its 787 jumbo jet, which contains a high percentage of titanium components to keep the weight under control. Flight tests of the 7E7 Dreamliner showed it was still too heavy and suggests even more components will be switched over to titanium in the production fleet.

Company info:

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 15% of the Company's sales revenue, during the year ended December 31, 2005, 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.

Position:
December $45 Call TIE-LI @ $5.70
Cost reduction: July $30 Put, -1.40, cost = 4.30

Insurance put: (closed 7/13)
July $30 PUT TIE-SF, 6/8 @ $2.00, exit 7/13 @ $3.40, +1.40


Entry $38.22 (5/28)

BHP - $42.62 - BHP Billiton Limited ** No Stop **

No change in play. We have a stealth rally underway in mining stocks and BHP continues to move higher although slowly ahead of earnings in August.

Current recommendation: Hold, Buy @ $40

Maintain a profit stop on the long $35 Put BHP-TG @ $31.

Earnings schedule: Aug 23rd

Company Info:

BHP Billiton Limited is a diversified resources group. The Company is an exporter of metallurgical coal for the steel industry; an exporter of energy coal; a producer of iron ore, copper, nickel metal, manganese ore, primary aluminium and manganese and chrome ferroalloys. It also has substantial interests in oil, gas, liquefied natural gas (LNG), diamonds, silver and titanium minerals. BHP Billiton operates in seven segments: Petroleum (oil, natural gas and LNG), Aluminium (aluminium and alumina), Base Metals (copper, silver, zinc and lead), Carbon Steel Materials (metallurgical coal, iron ore and manganese), Diamonds and Specialty Products (diamonds, titanium minerals and metals distribution), Energy Coal (energy coal) and Stainless Steel Materials (nickel metal, and chrome and nickel ferroalloys).

BHP is the second largest global producer of copper, 3rd largest producer of nickel, 4th in uranium, 5th in aluminum and zinc. BHP is also the number one sea borne supplier of coking coal and manganese. BHP also produces oil and gas.

Breakdown trigger $46.75 hit 5/15
Position: 2008 $50 LEAP Call LPH-AJ @ $7.50
Cost update: Closed June $40 Put 6/12, -1.10, cost = $6.40

Insurance put:
Closed: JUNE $40 Put BHP-RH @ $1.50 (5/22), exit $2.60, 6/8
Position: Aug $35 Put BHP-TG @ $1.30 (6/12)

Entry $46.75 (5/15)

MDR - $48.13 - McDermott ** Stop loss $38 **

MDR spiked +$3 higher ahead of Monday's earnings. Hopefully as positive surprise will appear. MDR hit a new high this week!

Current recommendation: Buy @ $43

Earnings schedule: August 7th

Company Info:

J. Ray McDermott is a leading provider of engineering, procurement, construction, and installation services for offshore oil and gas field developments worldwide. McDermott International, Inc. is a leading worldwide energy services company. McDermott's subsidiaries provide engineering, construction, installation, procurement, research, manufacturing, environmental systems, project management and facility management services to a variety of customers in the energy and power industries, including the U.S. Department of Energy.

3:2 split on June 1st reduced the strike price by 1/3 and increased the contract size to 150 shares.

Position 2007 $70 LEAP Call OYZ-AN @ $8.50
Split into 2007 $46.66 LEAP OYZ-AX @ $5.66
or
Position 2008 $75 LEAP Call YAE-AO @ $12.50
Split into 2008 $50.00 LEAP YAB-AJ @ $8.33
Cost increase put close 6/26 +1.40, cost = $9.73


Insurance put:
Position: August $36.625 Put MHH-TV @ $2.00, 6/13,
closed .60 6/26, -1.40


Position: June $60 Put MDR-RL @ $1.25 (5/22)
Split into June $40 Put MHH-RH @ $0.83, expired worthless 6/16


Entry $44.02 (5/18)

PTR - $112.50 - Petrochina ** No Stop **

No change in play. Still holding near two month highs. Keep the faith!

We have a 2008 LEAP and PTR could be $200 before expiration. As long as we maintain the positive trend the long-term price of oil should be our salvation.

Current recommendation: Hold

Earnings schedule: August 24th according to Ameritrade

Prior commentary:

Petrochina is the fourth largest energy company in the world. It is a government monopoly but it acts like an independent. PTR is aggressively acquiring leases and rapidly expanding its drilling program. It currently has over 10.9 billion bbls of proven reserves and more than 44 TCF of gas. Warren Buffet owns $2.3 billion of PTR stock. It trades at less than $12 per BOE and has a 3.5% dividend yield. PTR owns 14,000 service stations and has 2,900 franchised stations. It is majority owned by China and has unlimited capital for expansion if China likes the deal. I expect several acquisitions by PTR over the next couple years but with a $208 billion market cap and China as the owner it will not be a target itself. China would never give up control of those oil assets. PTR saw its output rise +6.3% in Q1 to 267.7 million bbls when most companies were posting declines in reserves and production. Gas output rose +35.6%. PTR owns 75% of the oil and gas reserves in China and supplies 40% of its needs. This is as close to a permanent lock on a profit as we can get given the rapid growth of China's economy.

Cramer has been pounding the table on PTR saying it was not afraid to drill in communist countries, places torn apart by strife or run by two-bit dictators like Chavez or Morales. With the Chinese government and military behind it there is little chance of somebody trying to confiscate PTR assets.

Company info:

PetroChina Company Limited operates a range of petroleum and related activities through four primary business segments: Exploration and Production Segment, Refining and Marketing Segment, Chemicals and Marketing Segment, and Natural Gas and Pipeline Segment. The activities include the exploration, development, production and sales of crude oil and natural gas; the refining, transportation, storage and marketing of crude oil and petroleum products; the production and sales of basic petrochemical products, derivative chemical products and other chemical products, and the transmission of natural gas, crude oil and refined products, and the sales of natural gas.

Position: 2008 $120 LEAP Call LJC-AD @ $16.20
Cost adjustment: Close short Dec $115 call +1.30 = $17.50
Cost adjustment: Close long July $90 puts +3.00 = $20.50

Insurance combo: Closed
Short: Dec $115 Call PTR-LC @ $3.20, 6/13, exit $4.50, -1.30
Long: (2) July $90 Puts PTR-SR @ $3.70, 6/13, exit $0.70, -3.00


Insurance puts: (Closed 6/7)
Closed: June $105 PUT PTR-RA, @ $4.20 (5/22), exit 6/7 @ $4.30

Entry 5/14 $116.20

CSX - $61.97 - CSX Corp ** Stop Loss $59 **

Is that a pulse? CSX finally moved higher after languishing for a week at support around $60. Maintain the stop and hope for a transportation rebound.

Earnings:

CSX Corp, posted earnings that beat the street by 51 cents and was +127% over the same quarter in 2005. They also announced a 2:1 stock split, a 10 cent post split dividend (+54%) and a $500 million buyback program over the next 12 months. They said business was so strong they expected to raise prices up by +6% this year and again in 2007. They did receive some insurance payments related to hurricane losses that inflated earnings slightly but were roughly equivalent to the profits they would have made without the hurricanes. The company said business was booming for as far out as they could see.

The insurance put is out of range but we will leave the profit stop on it just in case the market rolls over.

Current recommendation: Hold

Maintain a profit stop on the Aug $55 Put CSX-TK @ CSX $52

Earnings schedule: July 18th


Company Info:

CSX Corporation (CSX) based in Jacksonville, Florida, owns companies providing rail, intermodal and rail-to-truck transload services that combine to form transportation companies, connecting more than 70 ocean, river and lake ports. CSX's principal operating company, CSX Transportation Inc. (CSXT), operates the railroad in the eastern United States with approximately 21,000-mile rail network linking commercial markets in 23 states, the District of Columbia, and the Canadian provinces of Ontario and Quebec. CSX Intermodal Inc. (Intermodal) is a coast-to-coast intermodal transportation provider, an integrated intermodal company serving customers from origin to destination with its own truck and terminal operations, plus a dedicated domestic container fleet. Containers and trailers are loaded and unloaded from trains, with trucks providing the link between intermodal terminals and the customer.


Breakout trigger $60.50 hit Apr-3rd
Position: 2008 $65 LEAP Call YYD-AM @ $8.30
Cost update: Closed June $65 put, +3.05, cost = $5.25

Insurance Put:
Position: August $55 Put CSX-TK @ .95 cents. 6/12
Maintain profit stop at CSX $52.

Insurance Put: (closed 6/08)
Closed: June $65 PUT CSX-RM @ $1.20, exit 6/08, $4.25, +3.05

Entry $60.50 (4/03)

BTU - $49.01 - Peabody Energy ** No Stop **

BTU sprinted from just under $44 to nearly $53 on the jump in gas prices but gave back some gains on Friday. It still amounted to a +$3 gain for the week. Hope for more hot weather ahead.

Prior commentary:

BTU announced the acquisition of Australia's Excel Coal for $1.4 billion. The market liked the deal and BTU rose on the announcement. Excel is expected to boost its production from 5.6 million tons in 2005 to 15 million tons in 2007. BTU already produces about 60 million tons per quarter so at 2007 levels Excel will amount to about 6% of the 255 million ton total. The key to the equation is the distance from Australia to the high-demand markets like India and China as well as the volume of metallurgical coal Excel produces. If BTU is on the acquisition path James River (JRCC) and Foundation (FCL) have been rumored as targets as well as Massey Energy (MEE) and Consol Energy (CNX). Those would require a much stronger investment and face some regulatory hurdles.

We have been unbelievably unlucky on our insurance puts on BTU. Every one was filled near the highs for the day, low for BTU, and was followed promptly by a strong jump in BTU rendering our put worthless. I am hesitant to buy another one and I plan on selling an in the money calls when gas prices roll over. That collapse could last more than a month so we should be safe. I just want to get past the earnings before making any new moves.

Current recommendation: Buy under $40

Earnings schedule: July 20th

Company Info:

Peabody Energy Corporation (Peabody) is the largest 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.

Position: 2008 $55 LEAP Call LLW-AK @ $9.50
Cost increased 4/19 by +1.30 to $10.80
Cost increased 5/01 by +1.70 to $12.50
Cost increased 6/30 by +2.15 to $14.65

Insurance Put: (closed 6/30)
July $45 Put BTU-SI @ $2.40, 6/13, exit 6/30 @ .25, -2.15

Insurance put: (closed 6/9)
Closed: JUNE $52.50 PUT BTU-RT, @ $2.70 (5/22), exit $2.65, 6/8

April 8th covered call:
Sell June $60 Call BTU-FL @ $2.20, stopped $3.50, 4/19, -1.30

April 24th covered call:
Sell Sept $70 Call BTU-IN @ $4.20, exit $5.90 5/01 -1.70
Set stop loss at $67.50, hit 5/01
Set profit stop at $58.00, changed to 58.50 4/30

Entry $48.00 (3/07)

CCJ - $38.73 - Cameco ** No stop **

CCJ finally gave in to post earnings profit taking but continues to hold over $38. No change in play.

I am not going to buy another insurance put yet. Strong support at $35 should last unless the market implodes again. Hopefully the correction is past and only aftershocks remain.

Current recommendation: Hold

Earnings: July 27th, +138%

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.

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.

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 hit
Position: 2007 $80 LEAP ZBK-AP 1/2 position @ $10.60 (2/06)

Breakdown target $67.00 hit
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
Cost reduction: -.75 on 3/21, cost now $4.15

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

Put insurance: (expired 6/18)
Position: June $35 PUT CCJ-RG @ 1.20 (5/22), expired -1.20

Monday Mar-20TH cost reduction strategy:
Sell the June $40 call CCJ-FH @ $1.75
Set a profit stop at $33.50, hit 3/21, exit $1.00, +0.75
Set a stop loss at $39.95

HAL - $32.83 - Halliburton ** Stop Loss $30 **

HAL is holding its gains from the prior week and volume is positive. I raised the stop just in case but I am still a believer over $30.

Current recommendation: Buy over $30

Earnings: July 21st, +44% or $0.55 cents

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.

Halliburton was awarded a two-year contract with Statoil worth $193 million for cementing, drilling and completion fluid. Statoil said they were the largest contracts of their type awarded in 2006. In addition to the initial term there are three two-year extensions, which should bring the final value to somewhere in the $1 billion range allowing for adjustments.

Current position:
2007 (2) $40 LEAP Call HAL-AH @ 5.63
Cost adjustment:
Closed July $32.50 Puts, -1.55, new cost = $4.08

Original Position: 2007 $85 LEAP Call VHW-AQ @ $9.80
Monday March 20th: Position change
Sold the 2007 $85 LEAP VHW-AQ, exit $4.25.
Bought the 2007 $80 LEAP VHW-AP, entry $5.70.

Our adjusted cost in the 2007 $80 LEAPS is now $11.25
The strike is lower and will split into (2) $40 LEAPS @ $5.63

Insurance Put: (5/22) Contracts doubled by 2:1 split (HAL-SS)
Position: July $65 Put HAL-SM @ $1.00, exit $2.55 7/21

Insurance Put: (7/23)
August $27.50 Put HAL-TR @ $.45

Entry $39.50 (2/06)

VLO - $66.18 Valero ** No Stop **

VLO posted earnings that doubled on strong refining margins to $2.98 per share. Analysts were expecting $2.95. Revenue rose +49% to $26.78 billion. The CEO said it was one of the best quarters in the company history and the current quarter profits would be SUBSTANTIALLY ABOVE CURRENT ANALYSTS ESTIMATES! Surprisingly VLO sold off to $66 from its Wednesday high of $68.83. No change in play.

Current recommendation: Hold

Earnings Schedule: August 1st

Commentary from 6/18

Petrie Parkman analyst Chi Chow produced a 20-page report on Valero explaining why VLO trades at a discount to its peers. He blames it on the Valero spending spree that put Valero on the top in the United States. Despite very strong profits it left little cash to return to shareholders in the form of stock buybacks so prevalent recently. Valero also had a change in management with founding CEO Bill Greehey passing the baton to Bill Klesse. Chow thinks this is a very positive shareholder development. Chow suggested Valero sell five refineries currently processing the expensive light sweet crude and running on tight margins. Chow said Valero could get up to $5.8 billion in after tax proceeds. He also said Valero could generate $550 million from selling its retail gas stations and focus only on the refining business. He said Klesse is a shareholder friendly CEO and total share repurchases as a result of those actions above could amount to as much as $11 billion or up to 22% of outstanding shares.

This would be huge news and rumor has it that Valero is considering dumping some refinery assets in order to concentrate on the more profitable sour crude operations. This would be a windfall for shareholders and I hope it comes soon!


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.

Valero posted a company update on their website in late June. As part of the presentation they project higher earnings than the First Call consensus. Gasoline margins ytd in 2006 are up significantly over 2005. They expect strong year over year comparisons for Q2. According to Valero the US supply of on-road diesel is shrinking and Valero's margins are expanding. Valero estimates crude supplies will have to grow by +1.3 mbpd annually through 2010 just to stay even with demand. They see increased demand for light sweet crude and limited supply. Because Valero refines mostly sour crude their margins are significantly higher than other refiners.

The complete presentation can be viewed here:
<A href="http://media.corporate-ir.net/media_files/NYS/VLO/presentations/Roadshow_June.pdf" target="new">Presentation</a>

Merrill upped VLO to a buy on June 29th.

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
2/14 Cost increased by +0.15 on exited Mar-$45 put, now $1.75
4/11 Cost increased by +1.20 on CC stop loss, now $2.95
6/18 Cost increased by +1.50 on expired $55 put, now $4.45

Insurance put:
Position: June $55 PUT VLO-RK @ $1.50 (5/22), expired worthless

Monday Mar-20TH cost reduction strategy:
Sell the June $67.50 call ZPY-FR @ $1.25, exit 2.45, 4/11, -1.20
Set a profit stop at $53.75
Set a stop loss at $64.50

Monday Feb-13th
Set profit stop on March $45 put at $48 on VLO, exit $1.05 2/14
Insurance Put: March $45 Put VLO-OI @ $1.20
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.

Monday July 24th:
August $60 Put VLO-UL @ $1.20


Entry $52.30 (12/16)


Leaps Trader Watch List

Refinery Lotto

With Valero posting monster profits I believe we should continue to look at refineries as cash machines for our next round of entries. I am adding Frontier Oil as a potential play.

Frontier Oil has a positive buyback plan and a positive chart. We have played FTO in the past and I look forward to adding them in the future. Earnings are Monday so we get a free look at how the market reacts to their results.

Holly is another refiner with a positive outlook and chart. HOC saw earnings rise +82% in the report issued last Wednesday. Hopefully we will see some post earnings depression settle in as we await the next dip in oil prices.

Jim Brown
 

Dropped Entries

None


New Watch List Entries
FTO
Fontier Oil
HOC Holly Corp

Current Watch List

CEO - CNOOC Limited

CNOOC Limited is a producer of offshore crude oil and natural gas and an independent oil and gas exploration and production company. It mainly engages in oil and natural gas exploration, development, production and sales. The Company has four major oil production areas offshore China, which are Bohai Bay, Western South China Sea, Eastern South China Sea and East China Sea. It is an offshore oil producer in Indonesia. The Company also has certain upstream assets in regions, such as Africa and Australia. As of December 31, 2005, it owned net proved reserves of approximately 2.36 billion barrels-of-oil equivalent (BOE) and its annual average net production was 424,108 barrels-of-oil equivalent per day (BOEPD).

CEO has been rather volatile over the last year but the 50-week moving average currently at $75 has been decent support. The June drop in oil prices saw CEO trade as low as $70. I want to target the $70 level on any future dip.

CEO does not have LEAPS so I am going to email everyone the play particulars depending on when that $70 level is hit. Currently December is the longest option series available. I am hoping before $70 is hit a new series in 2007 will be added.

I repeat, we will buy the dip sometime in August. Details to follow at that time.

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

UPL - Ultra Petroleum

Ultra Petroleum Corp. (Ultra) 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 primarily in the Green River Basin of southwest Wyoming and Bohai Bay, offshore China. As of December 31, 2005, Ultra owned interests in approximately 148,007 gross acres in Wyoming covering approximately 230 square miles. The Company owns working interests in approximately 330 gross productive wells in this area and is operator of 53% of the 330 gross wells. Its domestic operations are focused on developing and expanding a tight gas sand project located in the Green River Basin in southwest Wyoming. During the year ended December 31, 2005, the Company's Wyoming production was approximately 87.4% of total oil and natural gas production on a thousand cubic feet of natural gas equivalent (MCFE) basis and 98.5% of the Company's estimated net proved reserves were in Wyoming on an MCFE basis.

Ultra has been extremely volatile for the last six months with the price of natural gas falling more than -50%. Ultra has current support at $50 but I would like to target something even lower if gas supplies hit a new record late in the summer. $40 would be my initial target depending on the price of oil and gas in September.

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

SU - Suncor

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. During the year ended December 31, 2005, the Company produced approximately 206,100 barrels of oil equivalent (BOE) per day, comprised of 174,500 barrels per day (bpd) of crude oil and natural gas liquids and 190 million cubic feet per day (mmcf/d) of natural gas.

Suncor has performed better than the sector over the last month and appears to be holding above $75. I would normally like to target the 200-day average in the $71 range but June's low of $68 is slightly below that average. That makes $60-65 a more likely target as a retest of that June low.


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

DO - Diamond Offshore

Diamond Offshore Drilling Inc. (Diamond Offshore) provides contract drilling services to the energy industry worldwide and is also engaged in deepwater drilling with a fleet of 44 offshore drilling rigs. The Company's fleet consists of 30 semisubmersibles, 13 jack-ups and one drillship. The Company's offers a range of services worldwide in various markets, including the deep water, harsh environment, conventional semisubmersible and jack-up markets. The Company provides offshore drilling services to a customer base that includes private and independent oil and gas companies and government-owned oil companies.

Diamond Offshore appears to have fallen out of favor with investors and has been on a steady decline since hitting $86 in early July. It has decent support in the $55-$60 range but we need to see a rebound appear before taking a position.

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

SLB - Schlumberger

Schlumberger Limited (Schlumberger) is an oilfield services company, supplying technology, project management and information solutions. Schlumberger consists of two business segments: Schlumberger Oilfield Services and WesternGeco. Schlumberger Oilfield Services is an oilfield services company supplying a range of technology services and solutions to the international oil and gas industry. WesternGeco, 70% owned by Schlumberger and 30% owned by Baker Hughes, is an advanced surface seismic company.

SLB has decent support at $55 and again at $50. SLB said business was booming in its July earnings release and yet it still sold off. I would initially target $55 but would want to see some buyers appear before making an entry.

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

WLT - Walter Industries

Walter Industries, Inc. (Walter) is a diversified company with seven operating segments: Mueller, Anvil, Industrial Products, Natural Resources, Homebuilding, Financing and Other. The Company's seven segments are further grouped into Water Products, Natural Resources, Homebuilding and Financing, and Other. The Water Products group, which consists of Mueller, Anvil and Industrial Products segments, manufactures water infrastructure and flow control products. The Natural Resources segment consists of coal mining and methane gas operations. Walter markets and supervises the construction of detached, single-family residential homes, primarily in the southern United States, through the Homebuilding segment. The Financing segment provides mortgage financing on such homes and purchases mortgages originated by others. The Other segment includes the manufacturing of foundry and furnace coke, slag fiber and specialty chemicals, as well as the Company's land division.

We are looking at Walter primarily for its coal and gas operations but water products is also doing well. Dragging WLT lower was the BTU warning and worries over its housing division. Strong support is $40 but like the others we want to see some buyers appear before we make an entry.

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

PBR - Petroleo 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 and distribution. The Company operates 95 platforms for production (72 fixed and 23 floating), 16 refineries, 30.318 kilometers of pipeline and 6,154 filling stations spread across the national territory. In addition, to its position in Brazil, Petrobras is present in 15 countries, such as Angola, Argentina, Bolivia, Chile, Colombia, Ecuador, the United States, Iran, Mexico, Nigeria, Paraguay, Peru, Tanzania, Uruguay and Venezuela. It also operates backup support of offices in New York, Tokyo, China and Singapore.

Petrobras has decent support at $85 and again at $80. I would like to see $80 again but we will monitor any drop for a hint of rebound. Try not to catch the knife.


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

SUN - Sunoco

Sunoco, Inc. (Sunoco), operates through its subsidiaries, as a petroleum refiner and marketer, and chemicals manufacturer with interests in logistics and cokemaking. The Company's petroleum refining and marketing operations include the manufacturing and marketing of a range of petroleum products, including fuels, lubricants and petrochemicals. Sunoco's chemical operations include the manufacturing, distribution and marketing of commodity and intermediate petrochemicals. The petroleum refining and marketing, and chemicals and logistics operations are conducted principally in the eastern half of the United States. Sunoco's cokemaking operations are conducted in Virginia, Indiana and Ohio. The Company operates in five business segments: Refining and Supply, Retail Marketing, Chemicals, Logistics and Coke.

SUN dipped to $63 last week before spiking back to more than $70 on acquisition news. Earnings are August 3rd. I would like to see them back at $60-$62 again but earnings will probably thwart that outlook.


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

FTO - Frontier Oil

Frontier Oil Corporation (Frontier) is an independent energy company engaged in crude oil refining and wholesale marketing of refined petroleum products. The Company operates refineries (the Refineries) located in Cheyenne, Wyoming, and El Dorado, Kansas, with a total annual average crude oil capacity of 162,000 barrels per day (bpd). Both of the Refineries are complex refineries, capable of processing heavier, less expensive types of crude oil, while producing gasoline, diesel fuel and other high-margin refined products. Frontier purchases crude oil to be refined and markets refined petroleum products, including various grades of gasoline, diesel, jet fuel, asphalt and other by-products. The Company focuses its marketing efforts in the Rocky Mountain region, which includes the states of Colorado, Wyoming, Montana and Utah, and in the Plains States region, which includes the states of Kansas, Oklahoma, Nebraska, Iowa, Missouri, North Dakota and South Dakota.

FTO has support at $30 and that would be my initial target with risk to $25.

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

HOC - Holly Corp

Holly Corporation is an independent petroleum refiner, which produces value light products, such as gasoline, diesel fuel and jet fuel. The Company owned and operated three refineries consisting of a petroleum refinery in Artesia, New Mexico that is operated in conjunction with crude oil distillation and vacuum distillation and other facilities (Navajo Refinery), refineries in Woods Cross, Utah (Wood Cross Refinery) and Great Falls, Montana (Montana Refinery). Holly Corporation has partnership interests in Holly Energy Partners, L.P., which acquires, owns and operates all of the refined product pipeline and terminally assets that support its refining and marketing operations in west Texas, New Mexico, Utah and Arizona, and a 70% interest in Rio Grande Pipeline Company. The Company deconsolidated HEP effective July 1, 2005. On March 2, 2006, the Company has entered into a definitive agreement with Connacher Oil and Gas Limited for the sale of the Montana Refinery.

Holly has support at $46 and I would take an entry there with risk to $40. However, we will wait for the next dip in oil prices to see if we might do better.
 


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