Option Investor

Weekly Newsletter, Sunday, 04/08/2007

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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

Iran Backed Down

With the third carrier group steaming full speed towards the Persian Gulf and rumors of attack plans the Iranian government caved in to growing pressure to release the British hostages. Now we are hearing from Britain that they were handcuffed, stripped, blindfolded and forced to stand against a wall while Iranian soldiers cocked weapons and shouted as though they were preparing a firing squad. The sailors were threatened with seven years in jail if they did not make statements claiming to be in Iranian waters.

We are also hearing this weekend that the US offered to "scare" Iran by mounting aggressive air patrols over Revolutionary Guards bases during the hostage standoff. Britain refused to let the situation escalate into a possible military confrontation. Britain reportedly asked the US to tone down activities in the Gulf to avoid agitating Iran to even further acts of violence. At London's request the two carrier groups in the gulf changed their exercises and moved away from Iran to make them appear less confrontational.

Apparently the capture was the result of a decision by a regional commander who was not acting on orders from higher up the chain of command. The situation started out as just a challenge and then escalated into the capture as events unfolded. The regional "accidental event" grew quickly into an international incident and the Iranian administration had to back the confrontation or risk losing face for a regional mistake. With the third carrier group heading for the gulf and the recent US military exercise involving 10,000 personnel and over 100 planes it appears Iran finally decided they could not benefit from continuing the crisis and could be in serious danger from the growing threat. Officially the release was in honor of Easter, Passover, the birthday of Muhammad and the magnanimity of the Iranian people. You chose the real reason.

Iranian President Mahmoud Ahmadinejad is planning a major announcement on Monday regarding Iran's nuclear program. April 9th is Iran's nuclear technology day and marks the first anniversary of its successful enrichment of uranium. Ahmadinejad will visit the enrichment facility in the city of Natanz where he is expected to make a major announcement. He is expected to claim that Iran has completed successful installation of a cascade of 3000 centrifuges at the plant. The announcement was expected back in February but delays in the process caused a postponement. This cascade is in direct violation of repeated ultimatums from the UN Security Council. The US has repeatedly refused to rule out military action if diplomacy fails to secure a halt in the process. It appears this could be coming to a head very soon.

Oil prices declined to initial support at $64 once the hostage deal ended and that is where it has rested for the last two days. A break of $64 targets $60 but with new hurricane warnings and gasoline inventories plunging I would be surprised to see it weaken much further. Gasoline inventories fell -5 million barrels in the last inventory report on Wednesday. Much of this is due to refinery problems but gasoline demand is also rising sharply and it is not even close to the summer driving season yet. Gasoline demand rose +241,000 bpd or +2.6% over the last week. That could be due to movement in pipelines, refinery surges and report timing but the number was a definite surprise. The more stable 4-week average is also showing a +1.7% increase in demand over 2006. Gasoline inventory levels have fallen below the 5-year average and that will provide even further support for prices.

The drop in oil prices after the hostage release was even more unusual given the sharp rise in gasoline prices. Gas prices rose +8.8 cents per gallon on Wednesday's inventory report. That equates to $4 increase per bbl oil. Instead oil fell over $2 from its high for the week. That is the equivalent of oil falling -$6 in price relative to gasoline once the crisis was over. If gasoline prices continue to rise as expected the price of oil is not going to spend much time under $64. Eventually the synchronization of gas/oil will return and oil will continue higher heading into summer.

Refiners continue to print money with the crack spreads reaching as high as $21.83 per barrel last week. The crack spread is the difference between the cost of the oil and the value of the refined products. It means they are making roughly $21.83 profit for every barrel they refine. Valero is making even more because it uses the much cheaper sour crude from the Middle East. This profit picture can't last simply because the refiners will catch up with annual inventory levels once the repairs and conversion to summer blends is completed. The spreads should return to something closer to normal at $8-$10 per barrel. That assumes the recent flurry of refinery outages does not continue and demand does not increase substantially heading into late spring.

The largest publicly traded oil companies plan to invest $97 billion this year to find and produce new oil. Unfortunately based on recent news reports about drops in currently producing fields and problems in Nigeria that investment may not succeed in increasing the daily production of oil.

Production from Mexico's Cantarell field fell to 1.57 mbpd in February from 1.57 mbpd in January. Only a year ago the field was producing over 2 mbpd. Production in 2007 is expected to average only 1.53 mbpd but continued sharp declines could put that number in jeopardy.

Gasoline in southern California has risen to within 20 cents of an all time high. Los Angeles rates are averaging $3.20 while unleaded in San Francisco is said to be selling as high as $3.75.

A proposal to build nuclear plants to supply electricity and steam to Alberta oil sands projects has run into problems in committee. A Canadian parliamentary committee advised that nearly 20 nuclear reactors would be needed to meet planned oil sands production growth through 2015. Why do they need so many plants? Because the natural gas they currently use to heat the sands is rapidly dwindling. The very ambitious oil production targets (mostly to be imported into the US) are being called into question by the shrinking supplies of natural gas. Billions of cubic feet are burned each month just to heat the sand until the oil liquefies and separates from the sand. I have reported on this impending shortage many times and the potential for future oil production targets to be missed. I seriously doubt 20 nuclear plants are going to be built even if the costs could be contained. The best answer is to find a way to burn some of the oil being produced as fuel for continuing production. Unfortunately it appears it would require burning almost as much oil as is produced making the process economically unfeasible. Once natural gas production in Canada declines to a point where prices and availability make it unfeasible to use for oil sands the entire oil sands project will stagnate at then current levels and future production targets will be erased. As oil prices continue to rise they will find other ways to create the energy needed to continue production but that could require oil at $100 a barrel or even higher.

You may have noticed that Cameco (CCJ) has taken off like a rocket. This is due to recent studies about future supply shortages and the rising price of uranium. Uranium has risen from $21 a pound to more than $95 in just the last three years. Recent comments from insiders suggest the price could double or triple again by 2010. Another uranium company taking off is Energy Metals. (EMU - no options) They began trading on the NYSE in November and seem to have taken off with the price of uranium.

Arch Coal said this week they were looking for acquisitions. Since the coal sector contains relatively few players that is a very small group of potential acquisition targets. Other coal companies include CNX, FCL, MEE, ARLP, ANR, JRCC, WLB, WLT, NRP, NCOC and EEE. I put together the sector list below to illustrate the potential targets. The only way to profit in these takeover targets is to own the stocks outright or own in the money calls. Buying an out of the money LEAP is a losing proposition since any eventual purchase removes the upside risk and LEAP premiums will implode. We already own Peabody and they are the largest and least susceptible to a buyout attempt. In related news the winter storm that dropped 2 feet of snow in Wyoming last week prevented more than 160 trains from being loaded and Union Pacific said it could take two weeks to recover from the storm. Burlington Northern would not say how many trains it missed loading.

Coal Sector List

You may have noticed the metals stocks also accelerating sharply. We have been unable to get an entry in ATI and I definitely do not want to chase it given the inflation in the LEAP premiums. As an alternative you may consider Rio Narcea Gold Mines (RNG $5) or Idaho Gen Mines (GMO $5). Both are gaining ground on the sharp jump in the price of nickel. Nickel is a commodity where supplies are shrinking and demand is booming. It is used in making steel with less corrosion properties. Neither have options but the price of the stock is less than the cost of a comparable LEAP.

Oil prices over the coming weeks are going to be pegged to the price of gasoline and subject to future hurricane forecast updates. I expect it to be lackluster until the next advance begins. With strong resistance at $67 we are likely to trade in a range from $64-$67 until something appears to produce a breakout.

Jim Brown

May Crude Futures Chart - Daily

May Gas Futures Chart - Daily

April Gasoline Chart - Daily


Changes in Portfolio

New Plays
None - See Watch List

Dropped Plays

New Watch List Plays Triggered

Portfolio Listing & Top Picks

New Plays

Most Recent Plays


Play Updates

Existing Plays

BHP - $49.48 +1.03 - BHP Billiton

BHP is knocking on the door at $50 and the continued rise in metals prices should keep pushing the price of BHP higher. No chance in play.

To see the initial commentary on this position click here:

Breakout target $43.50 hit March 12th

Position: JAN-09 $50 LEAP Call ZPK-AJ @ $6.00


CCJ - $46.15 +5.21 - Cameco

Cameco posted an update on its website regarding the Cigar Lake mine and it appears recovery efforts are preceding quickly. The Cigar Lake deposit is the second largest high grade deposit ever discovered. Cameco also announced that it would post a proxy statement on the site on April 10th for the upcoming special meeting of shareholders. Some feel that could include a new stock split. CCJ killed its shares back in 2005/2006 with a 3:1 split followed closely by a 2:1 split. That produced so many shares that forward progress was nearly impossible until everyone had finished rearranging their portfolios. Many funds have share limits and continued splitting forces these fund to sell shares putting pressure on the stock. No change in play.

To see the initial commentary on this position click here:

Breakout trigger: $37.50 Hit March 7th

Position: JAN-09 $40 LEAP Call ZBK-AH @ $7.80


PTR - $118.11 +1.02 - Petrochina

PetroChina is struggling with resistance at $120. The short June put from early March is going well. Currently it is valued at $1.15 and we sold it for $3.40. I considered closing it to reduce risk but I don't see PTR giving up $13. If we can close for 50-75 cents I would take it and we should have our chance over the next couple weeks. No news and no change in play.

To see the initial commentary on this position click here:

Breakdown targets:
$110 1/2 position - hit Mar-5th
$105 1/2 position - not yet triggered

Position: JAN-09 $120 LEAP Call ZJK-AD @ $10.70

Cost reduction play:
Position: Short June $105 Put PTR-RA @ $3.40, stop $100


SNP - $88.07 +3.59 - Sinopec

Lots of news on Sinopec but none of it directly related to the parent. SNP has eased over resistance at $87 but only barely. One more decent spike and we should see a sharp climb begin once that resistance is cleared. No change in play.

To see the initial commentary on this position click here:

Breakdown target $82.50 hit on 2/27

Position: OCT $85 Call SNP-JQ @ $7.00


CHK $32.51 +1.63 - Chesapeake Energy ** Stop loss $30.50 **

Chesapeake soared to another three month high on Friday and no weakness in sight. CHK won the Motley Fool march madness bracket beating out companies like MO, AAPL and other companies in its field. CHK sells for $.60 on the dollar of intrinsic value and holds 9 tcf of proven reserves and 18 tcf of probable reserves. Its current drilling program is attempting to monetize those reserves by converting them into proven assets. The founder/CEO continues to buy stock as though he was determined to take it back private. No change in play.

To see the initial commentary on this position click here:

Earnings: Feb-23rd, 90 cents vs est 76 cents.

Current recommendation: Hold

Position: 2009 $35 LEAP VEC-AG @ $5.30

Insurance put: none


MRO $102.79 +3.96 - Marathon Oil

MRO is VERY close to breaking out to a new historic high over $103.47. Refining is a good business today and Marathon is riding the wave. No news and no change in play.

To see the initial commentary on this position click here:

Earnings: Feb-1st 3.06 vs 3.43 (Q4/05) $1.08 billion profit

Current recommendation: Buy at $85

Position 2009 $100 LEAP Call VXM-AT @ $12.60
Cost update: Expired March put +65 cents to $13.25

Insurance put: 2/18/07
Position: March $85 PUT MRO-OQ @ 65 cents. expired


HES - $56.29 +.82 - Hess Corporation
(Formerly (AHC))

Hess is consolidating its recent gains and remains close to its historic high at $58. No news. I considered closing the insurance put but for 30 cents I would rather have the insurance for another 6 weeks at $50.

To see the initial commentary on this position click here:

Earnings schedule: April 25th

Earnings: Jan 31st, $1.13, vs $1.44 in Q4/05, 230% replacement

Current recommendation: Buy at $47

11/05/06 2009 $50 LEAP Call VHS-AJ @ $6.80
Cost adjustment put exit +1.60, cost = $8.40

Insurance Put: Triggered Jan-3rd @ $49
01/03/07 May $45 put HES-QI @ $2.60, exit 1/26 $1.00

Insurance Put: 2/26/07
MAY $50 PUT IGG-QJ @ $1.35, profit stop $46


BTU - $43.74 +3.50 - Peabody Energy

The winter storm in Wyoming may have helped the coal companies more than hurt them. The storm prevented more than 200 trains from being loaded and rail companies say it could take two weeks before conditions return to normal. The short-term drop in coal shipments caused a draw down in inventory levels at power plants serviced by the Powder River Basin. This could help ease some oversupply that has been plaguing coal companies since the record warm winter in 2005. No other news.

SELL JAN-08 $30 PUT LLW-MF is BTU touches $35

To see the initial commentary on this position click here:

Earnings: Jan-25th +42% including special items.

Current recommendation: Buy at $37.50

10/22/06 Jan-2009 $50 LEAP Call ZZT-AJ @ $8.70
02/05/07 March put stopped -$1.00, cost = $9.70

Insurance put: Triggered with drop through $39
01/03/07 March $35 Put BTU-OG at $1.15, stopped @ $42.50


SLB $71.84 +2.74 Schlumberger

SLB finally broke free of gravity and resistance at $69. Friday's close was a new 10-month high and $75 will be a new historic high. SLB warned against a mini-tender offer by TRC Capital who offered to buy up to 1.5 million shares at $67.75. That was -5% below the current price when the offer was made. No change in play.

To see the last full commentary on this position click here:

Earnings schedule: April 20th.

Earnings: Jan 19th, +71% to $1.13 billion

Current recommendation: Buy at $60, stop at $55

LEAP Position:
1/2 9/11/06 @ $8.60
1/2 9/12/06 @ $8.00
Position: 2009 $70 LEAP Call VWY-AN @ $8.30
Cost update for expired Jan put +2.00 = $10.30

Insurance Put: 9/18
Position: Jan $50 Put SLB-MJ @ $2.00, expired


SUN $74.17 +3.73 - Sunoco

SUN continued to move higher and the option activity from the prior week as abated. Evidently there was no takeover offer coming as many had expected. An upgrade for the sector on Thursday provided another spike. No news.

To see the last full commentary on this position click here:

Earnings schedule: May 3rd

Earnings: Jan-31st, -57% $1.00 vs $.96 analyst est.

Current recommendation: Buy at $60, stop at $54

LEAP Position:
9/12/06 Position: 2009 $70 LEAP Call VUN-AN @ $13.50
Cost update expired Jan put +2.40 = $15.90

Insurance Put:
Position: Jan $55 Put SUN-MK @ $2.40, expired


VLO $66.01 +1.52 - Valero Energy

Valero hit a new 7-month high again on Friday although it had a tame week relative to some other refiners. Given its $20 rise in the last three months it needed some consolidation time. Part of the problem was news that some Valero gas stations were experiencing gas shortages due to the temporary shutdown of the Texas panhandle refinery. No change in play.

To see the last full commentary on this position click here:

Earnings schedule: April 24th

Current recommendation: Buy at $50, stop at $45

LEAP Position:
9/24/06 Position: 2009 $60 LEAP Call VHB-AL @ $7.70
Cost update expired Jan put +2.25 = $9.95

Insurance Put:
Position: 9/25 Jan $45 Put VLO-MI @ $2.25, expired


DO - $82.30 +1.35 - Diamond Offshore ** Stop $73.00 **

DO is creeping upward with resistance at $82.50 and it appears a breakout is imminent. A move over $85 should produce some real speed. No news and no change in play.

To see the last full commentary on this position click here:

Earnings schedule: Feb-8th

Current recommendation: Buy at $75, stop at $69

LEAP Position:
8/29/06 Position: 2009 $80 LEAP Call VCT-AP @ 14.20
Cost reduction: Oct $70 Put profit -3.15, cost now $11.05
Cost increase: Dec $60 put expired -2.40, cost now $13.45

Insurance Put:
10/08 Dec $60 Put DO-XL @ $2.40, expired

Position closed:
10/03 October $70 put DO-VN @ $1.65, exit @ $4.80, +3.15

Non-Energy Positions

BZH - $28.64 -0.39 - Beazer Homes ** LEAP PUT **

Beazer is being flooded with suits, some seeking class action status on charges it practiced predatory lending, filed illegal loan documents and manipulated its stock price. These types of suits appear whenever bad news appears about a company but in this case it looks grim.

To see the last full commentary on this position click here:

Position: Jan-08 $25 PUT WZF-ME @ $3.10

No stop loss

Leaps Trader Watch List

Dropped Entries

New Watch List Entries
I am planning on adding HAL once we see what the KBR spinoff does to the stock. The spinoff was completed on Friday and next week should be the key.

I am still looking at adding some metals stocks and transportation stocks but we are not seeing any weakness to buy.

It is boring not to add anything but not as painful as adding them at a top.

Current Watch List

UPL - Ultra Petroleum ** New Target, New Strike **

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.

Breakdown target $50

Buy JAN 2009 $60 LEAP Call OZH-AL


ATI - Allegheny Tech ** New target, New strike **

Allegheny Technologies Incorporated (ATI) is a diversified specialty metals producer. The Company operates in three segments: High Performance Metals, Flat-Rolled Products and Engineered Products. The High Performance Metals segment produces, converts and distributes a range of high-performance alloys, including nickel and cobalt-based alloys and superalloys, titanium and titanium-based alloys, zirconium, hafnium, niobium, nickel-titanium and their related alloys. The Flat-Rolled Products segment produces, converts and distributes stainless steel, nickel-based alloys, and titanium and titanium-based alloys. The Engineered Products segment produces tungsten powder, tungsten heavy alloys, tungsten carbide materials and carbide cutting tools. ATI products are used in various markets. These markets include aerospace, defense, chemical process industry, oil and gas, electrical energy and medical.

Breakdown target $104.50

Call spread:
BUY JAN-09 $110 LEAP Call OYG-AX


TEX - Terex Corp

Terex Corporation (Terex) is a diversified global manufacturer of capital equipment delivering solutions for the construction, infrastructure, quarry, mining, shipping, transportation, refining and utility industries. The Company operates in five business segments: Terex Construction, Terex Cranes, Terex Aerial Work Platforms, Terex Materials Processing & Mining, and Terex Roadbuilding, Utility Products and Other. The Company's products are manufactured at plants in North America, Europe, Australia, Asia and South America, and are sold primarily through dealers and distributors worldwide. During the year ended December 31, 2005, it acquired Halco Holdings Limited and its affiliates, and Power Legend International Limited and its affiliates. It entered into a joint venture with North Hauler Joint Stock Company Limited to produce high-capacity surface mining trucks in China. It has a 50%-ownership interest in Sichuan Changjiang Engineering Crane Co., Ltd.

Breakdown target $66.00

Call spread


TSO - Tesoro ** New target **

We were stopped out of our highly profitable TSO position and now we are looking to get back in with a different strike on the next dip in refiners. Unfortunately there has been no dip.

Company info:

Tesoro Corporation (Tesoro) is an independent petroleum refiner and marketer with two operating segments: refining, which is engaged in refining crude oil and other feedstocks at its six refineries in the western and mid-continental United States and selling refined products in bulk and wholesale markets (refining), and retail, which is engaged in selling motor fuels and convenience products in the retail market through its 460 branded retail stations in 18 states. Through its refining segment, the Company produces refined products, primarily gasoline and gasoline blendstocks, jet fuel, diesel fuel and heavy fuel oils for sale to a variety of commercial customers in the western and mid-continental United States. Tesoro's retail segment distributes motor fuels through a network of retail stations, primarily under the Tesoro and Mirastar brands.

Breakdown target: $100

BUY 2009 $110 LEAP Call ZGC-AB


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