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Weekly Newsletter, Saturday, 07/14/2007

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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

Starting to Worry

The price of oil closed at 73.97 when trading ceased for the weekend. This was exactly one year since the prior high for oil was made on July 14th 2006. Prices stayed at that level for about three weeks before rolling over into a dive that took -$15 off the price in a very short period of time.

Almost exactly the same scenario is setting up for this July. Strong demand and promises of an active hurricane season that never appears. Unfortunately in trading we know that past repeatable events tend to be hedged by a week or two when the scenario repeats. Traders who understand the scenario don't wait until the last minute to change directions. They tend to enter earlier and earlier each time the scenario repeats. That suggests we are very close to a top assuming no hurricanes appear.

Helping to push crude prices higher in spite of decade high inventory levels has been the refinery crisis. With capacity utilization running -5% or more under normal the fear of gasoline shortages has pushed gas prices higher and crude prices followed. For most refiners gasoline production requires light WTI crude and WTI has seen the strongest demand.

Last week gasoline prices fell from Tuesday's high of $2.38 to Friday's close at $2.25 a drop of -5.5%. $2.20 is strong support but once traders decide there is enough gasoline in inventory to last the rest of the summer the dump will begin and gasoline prices will plummet. Once gasoline cracks crude will be only a heartbeat behind it and it will be ugly.

I expect the drop in crude prices to be hard and fast because current net long positions in crude futures are at record levels. OPEC has managed the price perfectly and production problems at various fields around the globe have added to the price pressure and investing interest. Without a hurricane the decade high inventory levels will begin to weigh on prices. The last time inventory levels were this high oil was under $20 a barrel.

The International Energy Agency, advisor to the worlds 26 most advanced economies, continues to repeat a call for OPEC to ramp up production to add to global inventory levels before Q4 demand arrives. The IEA trimmed its 2007 demand projections by 100,000 bpd to 86 mbpd for all of 2007. Demand for 2007 is expected to rise by 1.8% or 1.5 million barrels per day over 2006. Oil demand for 2008 is expected to rocket higher by 2.5% or an additional 2.2 mbpd to 88.2 mbpd.

The disturbing portion of this report was the cut in production expectations of 410,000 bpd from non-OPEC sources from prior estimates. The agency said "unscheduled outages" are now a part of the industrial landscape for the oil industry. They blamed this on aging infrastructure. OPEC demand is expected to rise to 32 mbpd in 2008 compared to June's 30.17 mbpd of production.

The IEA admitted it had been too optimistic in past years about new production capacity coming online and is toning down production estimates to take into consideration delays in projects and those unscheduled outages. They have yet to mention the biggest problem of all and that is depletion at existing fields. It is as if they feel if they don't mention it the problem will go away. They can just say new demand will be X and expected production additions will be Y and hope those two numbers are equal. Somehow I think reality has to enter the mix eventually and no amount of confusing press releases will help.

They also said prices over $70 a barrel would depress demand as it did in 2006. When prices passed $70 in 2006 demand growth dropped from a +2% pace to end the year at only +0.9% due to voluntary and forced restrictions on gasoline purchases. People simply drove less and global demand slowed. The IEA is expecting that to happen again in 2007 but to less extent. Each time prices dip they dip from a higher level to a higher level and consumers adjust to the new range until the next price hike begins again. As long as the world continues to produce nearly 35 million vehicles a year demand will continue to climb. Current global vehicles are thought to be in range of 730 million and are expected to hit 1 billion by 2015. That one fact alone should be enough to convince everyone that we are going to be in a world of trouble very soon. Transportation as we in America know it is about to change dramatically.

The table below is the actual demand and production numbers for 2006, 2007 and estimates for each quarter through the end of 2008. I added a line to show the difference between the actual production and the demand. You can see we have been living off oil in inventory during the high demand months and then adding to that inventory in slack months. Unfortunately the trend towards more negative quarters is growing. Note that production from Q1-2006 to Q4-2008 is expected to rise +4.3 million barrels per day. I believe that is wishful thinking and it will be tough to reach that 88.9 mbpd demand level. Remember also that the IEA has admitted their oil production estimates for the last 5-years have been too optimistic.

IEA Crude Projection Table.

Just when refiners were starting to come back online and pickup speed the BP refinery in Whiting Indiana crashed. This is a 250,000 bpd refinery and it has been offline for a week with an expected restart this weekend but it will impact the inventory numbers for next Wednesday's report. The refinery accounts for 1.4% of US refining capacity and produces 800,000 barrels of gasoline per week. It uses 1.6 million barrels of oil in the process. With this refinery offline for over a week you can see how that will impact the next inventory report. Oil levels should rise and gasoline levels should fall. Imports of gasoline increased another 30,000 bpd to 1.423 mbpd for the week.

Brent light crude closed at $77.68 on Friday with prices holding above WTI crude due to continuing problems in North Sea production. Many of these problems should be corrected over the next couple of weeks and Brent crude should begin to fall. This will be another drag on WTI prices here in the US.

Because of what could be an impending drop in crude prices I am raising the stop losses again and I am going to institute a couple hedge plays to capitalize on the drop if/when it appears.

Jim Brown


August Crude Futures Chart - Weekly

August Gas Futures Chart - Daily

August Gasoline Chart - RBOB Daily

 


Changes in Portfolio

New Energy Plays
XLE Oil Drop Hedge Put  
OIH Oil Service Holders ** Optional **
XOI Amex Oil Index ** Optional **
DUG UltraShort Oil  & Gas ProShares ** Optional **

New Non-Energy Plays

None ahead of earnings


Dropped Plays

None


New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

The official hedge play will be puts on the XLE. I am also profiling several additional hedges for those that feel a little more aggressive. They are NOT official positions. The initial target for a crude correction would be a drop to $64 with a secondary target at $60. This is a short-term play of 4-6 weeks with expectations for crude to rebound by the middle of September at the latest. Sept 10th is the peak of the hurricane season and once past the 10th crude prices should move up sharply to accommodate the Q4 demand and OPEC's unwillingness to increase production.

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XLE - Oil Drop Hedge Put

Stock Info:

Energy Select Sector SPDR Fund (the Fund) seeks to replicate the total return of the Energy Select Sector of the S&P 500 Index. The Fund utilizes a passive or indexing investment approach and attempts to approximate the investment performance of the Energy Select Sector Index, by investing in a portfolio of stocks that seek to replicate the Energy Select Sector Index. The Energy Select Sector Index includes companies from oil, gas and consumable fuels, and energy equipment and services industries. Energy companies in the Energy Select Sector Index develop and produce crude oil and natural gas, and provide drilling and other energy resources production and distribution-related services.

Breakdown trigger: $72

Buy Dec $70 Put XBT-XR

Initial profit target: XLE $65, secondary target XLE $60


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Optional Suggestions
Not official positions!
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OIH - Oil Service Holders

Stock Info:

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 trigger: $173

Buy Oct $170 Put OIH-VZ

Initial profit target: $150, Secondary target $140

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XOI - Amex Oil Index

Index Description:

The Amex Oil Index is a price-weighted index designed to measure the performance of the oil industry through changes in the price of a cross section of widely held corporations involved in the exploration, production and development of petroleum. The XOI Index was established with a benchmark value of 125.00 on August 27th, 1984.

Breakdown trigger 1460

Buy Oct 1360 Put XCY-VL

Initial profit target: 1300, secondary target 1250


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DUG - UltraShort Oil & Gas ProShares

The UltraShort Oil & Gas ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas Index. (DJUSEN)

Buying DUG is the same thing as shorting the index only DUG has a 200% compounding factor.

Breakout trigger: $45

Buy DUG, target $52


 


Play Updates

Existing Plays

RIMM - $227.52 +12.17 - Research in Motion

RIMM continued its unbelievable ride with another $12 gain. The mid week profit taking was minimal and the sprint higher continues. I am kicking myself for not making a simple long entry instead of a spread but with calls $20-$30 a piece at the time it seemed like the right move. We should still exit with a $30 profit once the premium decay ends from both options going into the money.

For initial commentary see the July 1st newsletter.

Breakdown trigger: $168.00 hit 6/25

Call spread:
Position: LONG 2009 $180 LEAP Call VHO-AP @ $32.60
Position: SHORT 2009 $230 LEAP Call VHO-AF @ $10.47

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NOV - $111.85 +1.74 - National Oilwell ** Stop Loss $105.50 **

No news for NOV but the rally continues. NOV appears to be nearing another breakout phase. I raised the stop again to take us out with a profit should oil crash.

For initial commentary see the July 1st newsletter.

Earnings Schedule: July 25th

Breakdown trigger: $100 hit 6/27
(no leaps)

Position: Feb 2008 $110 Call NOV-BB @ $10.50

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GSF - $73.05 -2.02 - GlobalSantaFe *** Stop Loss $71 ***

GSF gave up ground all week and the BHI warning did not help. I raised the stop again just in case. There was no news.

For initial commentary see the July 1st newsletter.

Earnings schedule: Aug 1st

Breakdown target: $70 Hit 6/27

Position: 2010 $80 LEAP Call WEJ-AP @ $10.10

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CNQ $70.77 +2.97 Canadian National Res ** Stop Loss $66.50 **

The rebound continued on no news. I raised the stop again to protect the position.

For initial commentary see the July 1st newsletter.

Earnings schedule: Aug 2nd

Breakdown target: $65 Hit 6/25

Position: Jan 2009 $70 LEAP Call OKR-AN @ $9.50

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NOK - 29.91 +0.99 Nokia

Nokia bounced again to another new high on news they were going to allow Skype calls on their N800 Internet Tablet Smart Phone. This is also a positive for Ebay, which owns Skype.

For initial commentary see June 24th newsletter

Earnings schedule: Aug 2nd

Breakdown trigger: $28.00 Hit 6/21

Position: 2010 $30 LEAP Calls WIK-AF @ $4.90

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BRS - $53.06 +2.16 Bristow Group ** Stop Loss $50.50 **

Bristow finally came back to life and rallied to a new historic high. I raised the stop again.

For initial commentary see June 17th newsletter

Earnings schedule: Aug 3rd

Bristow has no LEAPS

Breakout trigger: $50.50 hit 6/14

Position: Dec $50 Calls BRS-LJ @ $5.00

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MDR - $92.09 +2.20 - McDermott Intl ** Stop Loss $86 **

MDR shook off the midweek weakness and rallied to another new high with a nice +3.42 gain on Friday. I raised the stop loss just in case.

For initial commentary see June 17th newsletter

Earnings schedule: No date yet

Breakout trigger: $78.00 Hit 6/11

Position: 2009 $80 LEAP Call OYZ-AP @ $9.80

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HOS - $40.37 +1.04 - Hornbeck Offshore *** Stop $38.75 ***

No news on HOS and a minor move. I raised the stop again to take us out on any future weakness.

For initial commentary see June 10th newsletter

Breakdown trigger: $39.00 hit 6/08

Position: 2009 $40 LEAP Call ZIG-AH @ $8.00

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HDY - $2.98 +0.03 Hyperdynamics Corp

Still waiting for the contract to be ratified. The special session of the Guinea National Assembly began on July 6th and the contract has been given priority status and could become a special law by the end of next week.

The Guinea National Assembly is going to ratify the HDY contract for revenue sharing before the current special session closes. This contract when ratified will become a "Project of Law" or super contract that cannot in normal circumstances be broken. Once the contract is ratified HDY will begin a rapid development phase on its 31,000 square mile lease.

For initial commentary see June 3rd newsletter.

Position: HDY stock @ $2.44

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TSO - $59.20 +0.29 - Tesoro *** Stop Loss $56.50 ***

TSO is starting to weaken and with gasoline prices falling we may get taken out of this position next week. I raised the stop once again.

For initial commentary see April 29th newsletter.

Earnings schedule: Aug 7th

Breakout target: $55 hit 10:AM on 4/23/07

Position: 2009 $120 LEAP Call ZGC-AD @ $16.68
Post split: (2) 2009 $60 LEAP Calls ZGC-AL @ $8.34

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ATW $71.34 -0.53 - Atwood Oceanics ** Stop Loss $67 **

Another nice week until Wednesday's drop knocked ATW back to $70. The trend appeared to recover by Friday's close. ATW is a potential takeover candidate. No news and no change in play.

Interesting article in Investors Business Daily regarding Atwood.

For initial commentary see April 29th newsletter.

Earnings schedule: Aug 8th

Breakout trigger $60.50 hit 4/23/07
Position: 2009 $70 LEAP Call ZFJ-AN @ $6.50

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BHP - $67.96 +2.68 - BHP Billiton *** Stop Loss $64.50 ***

BHP continues to set new highs and the feeling now is Alcoa may be too expensive to tackle. BHP had been rumored to be considering a bid for Alcoa but the end to the Alcan deal sent Alcoa surging another $5 to a market cap of $41 billion. Add in a premium and that may price Alcoa out of the market. BHP is rising on the thought that they will pass on Alcoa and pickup a couple smaller companies to fill holes in their portfolio. BHP has risen more than 50% since we entered this position back in March.

The $40 billion gain in market cap by BHP in the last two months has taken them off the potential hit list for a China takeover. With a market cap of $200 billion today they are too pricey even for China.

For initial commentary see March 17th newsletter.

Earnings schedule: Aug 22nd

Breakout target $43.50 hit March 12th

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

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CCJ - $50.65 +.39 - Cameco *** Stop Loss $47.50 ***

The early week bounce was sold midweek and we ended about where we started the week on CCJ. Uranium prices actually fell last week for the first time in over 4 years from $138 to $135 per pound. That produced a near panic in several other uranium stocks but CCJ barely budged. I am going to keep the stop in place just in case.

In April Cameco projected sales would be 50% higher in 2007.

Worldwide there are 24 new reactors being built, 41 on the drawing boards and 113 in the proposal stages. If all were built it would be a 50% increase from the 435 reactors now in operation. In 2006 the world consumed 180 million pounds of uranium but produced only 103 million pounds. The rest came from Russian nuclear warheads being decommissioned. The supply from those warheads is dwindling and will be completely gone by 2015.

For initial commentary see March 10th newsletter.

Earnings Schedule: July 30th

Breakout trigger: $37.50 Hit March 7th

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

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PTR - $158.78 +1.28 - Petrochina *** Stop Loss $152.50 ***

What! Only a dollar gain? PTR has been so strong, +$9 in the prior week that a mere buck gain is almost unheard of. It remains pegged to the historic high at $160 and ready to run once again. PTR said it hired UBS to manage its Shanghai IPO in November. The IPO in that market is expected to raise another $6.6 billion. We are up +$39 in this one position! I raised the stop again.

For initial commentary see March 10th newsletter.

Breakdown target:
$110 1/2 position - hit Mar-5th

Position: JAN-09 $120 LEAP Call ZJK-AD @ $10.70
Cost reduction 4/19 $10.70 -2.25 = $8.45

Cost reduction play:
Position: stopped @ $114 4/19
Short June $105 Put PTR-RA @ $3.40, exit $1.15. +2.25

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CHK $36.32 +1.07 - Chesapeake Energy ** Stop loss $33.50 **

CHK surprised traders with a whopping big deal with Anadarko. Under the agreement the pair will jointly explore more than one million gross acres in the Deep Haley area and split drilling, completion, production and midstream operations. Anadarko received $310 million in cash and other consideration along with 50% of certain Chesapeake assets. It was a complicated swap but the bottom line is CHK grabbed a massive mount of acreage and continues to build a huge portfolio of gas properties. Maintain the stop at $33.50 but don't close the put if the LEAP is stopped. No change in play.

For initial commentary see Dec-9th newsletter.

Earnings schedule: Aug 2nd

Current recommendation: Hold

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

Insurance put:
Oct $30 Put CHK-VF @ 90 cents. Profit stop $28

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MRO $65.04 +1.45 - Marathon Oil *** Stop Loss $61.00 ***

MRO hit a new four-week, post split high on Friday and appears to be shaking off the weakness in the refiner sector. I would not hold my breath that this will last. MRO did say production levels had been in the 345,000 bpd range and right in their estimates. However, they claimed they were receiving a higher price than previously expected for their production. Prices received rose +4.95 per barrel domestically and +9.79 internationally. MRO also said it purchased $2.5 billion in stock during the quarter.

I raised the stop again. Even good news can't fight falling crude prices.

For initial commentary see Nov-18th newsletter.

Earnings schedule: July 31st

Current recommendation: Buy above $60

Position 2009 $100 LEAP Call VXM-AT @ $12.60
Cost update: Expired March put +65 cents to $13.25
Post split: (2) 2009 $50 LEAP Calls VXM-AJ @ $6.62

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

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SLB $89.64 +1.31 Schlumberger *** Stop Loss $85.50 ***

SLB hit a new high on Friday one week ahead of its earnings scheduled for next Friday. I raised the stop again in case earnings are a disappointment. BHI warned last week so SLB could be in danger.

For initial commentary see Oct-14th newsletter

Earnings schedule: July 20th

Current recommendation: hold

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
Cost update for expired June put +1.15 = $11.45

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

Insurance put:
Position: June $70 PUT SLB-RN @ $1.15, expired

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SUN $84.05 +1.97 - Sunoco *** Stop Loss $81.00 ***

SUN continued its leisurely 3-week climb but refiners should be the first to crack once gasoline prices break that $2.20 support level. Maintain the raised stop at $78.50.

For initial commentary see Oct-14th newsletter

Earnings schedule: Aug 1st

Current recommendation: Hold

LEAP Position:
9/12/06 Position: 2009 $70 LEAP Call VUN-AN @ $13.50
Cost update expired Jan put +2.40 = $15.90
Cost update expired June put +0.85 = $16.75

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

Insurance put:
Position: June $70 PUT SUN-RN @ 85 cents, expired.


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Non-Energy Positions
****************************

BZH - $23.62 -.36 - Beazer Homes *** STOP LOSS $25.00 ***

Beazer rebounded off its new 52-week lows at $21.80 on the general strength in the housing sector on Friday when it was rumored Warren Buffett was interested in Honvnanian. Earnings were announced for the 26th. Hopefully they will confess their crimes and head for single digits.

Beazer has several suits pending, some seeking class action status on charges it practiced predatory lending, filed illegal loan documents and manipulated its stock price.

For initial commentary see March-31st newsletter

Earnings schedule: July 26th

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


Leaps Trader Watch List

Dropped Entries

None


New Watch List Entries

None

Current Watch List

UPL - Ultra Petroleum

UPL failed to fall on the implosion in gas prices. I believe it will eventually break so I am not changing the entry.

This is an unbelievable opportunity in progress. For some reason UPL has fallen out of favor even though production is rising and they are the lowest cost producer in North America. Cash flow in Q1 increased +15% on a +42% increase in production to record levels. They closed 2007 with more than 10 TCF of gas reserves in Wyoming and Utah. They have a 17 year drilling program on those assets alone. They raised guidance for 2007 to 114 BCFE for a +24% increase over 2006. Estimates for 2008 are 135 BCFE and 160 BCFE for 2009. They added $250 million to a $1 billion share repurchase agreement on April 30th. This company is printing money but suddenly the stock has fallen out of favor with investors. I would love to be a buyer at $50. Falling gas prices may give us a chance.

Company Info:

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 primarily in the Green River Basin of southwest Wyoming and Bohai Bay, offshore China. As of December 31, 2006, Ultra owned interests in approximately 147,917 gross (79,566 net) acres in Wyoming covering approximately 230 square miles. The Company owns working interests in approximately 464 gross producing wells in this area and is an operator of 50% of the 464 gross wells. During the year ended December 31, 2006, domestic production was approximately 89.5% of the Company's total oil and natural gas production on a thousand cubic feet of natural gas equivalent (Mcfe) basis and 99% of the Company's estimated net proved reserves were domestic on a Mcfe basis.

Breakdown target: $50

Buy Jan 2009 $60 LEAP Call OZH-AL
 


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