Option Investor

Weekly Newsletter, Saturday, 07/21/2007

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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

Bearish Divergence

The price of gasoline fell -13% from the prior week's high to the Tuesday low but crude prices continued higher. This divergence can't continue and they will eventually return to trade in lock step. Since driving season is nearly over the odds are good gasoline will not rebound much higher. Once more leg down in gasoline prices is all it should take to grease the skids under the price of oil.

The price of the futures contract over the next several months is already showing what is called "backwardization." Backwardization is where futures for forward months trade at a lower price than the current contract. Normally futures trade higher on the combination of risk and time. Higher prices for future contract months is called a contango. Producers always hope for a contango so they can pre-sell their production for more than the current spot prices. In theory futures prices will always decline to meet the spot prices rather than spot prices rise to meet the futures. It does not always work like that but a contango does represent a positive profit potential for producers. A market in backwardization makes it more profitable to sell production on the spot market rather than pre-sell it into the futures market. The ranges we are seeing right now may technically be called backwardization but the difference in price is negligible. We have not seen this in many months so this is yet another sign that oil prices may be about to crack.

You would not expect a break in oil prices from looking at the September crude chart. It has been rising steadily despite crude inventories reaching 10-year highs. The fear of a hurricane disruption is thought to be the reason but there are other factors supporting the market.

OPEC always claims there is plenty of oil on the market. There probably is but there is not enough light crude on the market. I have used the analogy many times about a driver pulling his diesel car into the service station for a fill up. The station tanks could be over flowing with regular, plus and super unleaded but if they have no diesel the driver is out of luck. The world is overflowing with various grades of crude but the critical light sweet grades are the ones in high demand.

With the new emission rules most refiners need to start with a lighter grade of crude to produce the very low emission fuels. Very few refineries can produce gasoline from the heavy sour grades of crude. Valero is the main exception with the ability to process the cheaper sour crude.

The light crude problem is worse because of the problems in Nigeria and the North Sea. Nigeria is a large producer of light crude with production of more than 2.5 mbpd when they are operating at full production. Violence in their country has shutdown over 750,000 bpd of this light crude production called Bonny light.

Problems with several platforms and a pipeline in the North Sea has crimped production of Brent Light Crude by somewhere in the neighborhood of 150-300,000 bpd. This shortage of light crude on the global scale has already pushed the price of Bonny light crude over $80 since July 9th. Louisiana Light Sweet crude (LLS) hit $80 last week. The benchmark WTI crude now at $76 is likely to hit $80 next week but that could be the end of the road.

Nigeria is attempting to restart production that has been shutdown for many months. This may be a futile effort but the government must get control soon to revive the government. Nigeria is losing $1.3 billion a month due to drops in production. However, an apparent kidnapping attempt of a Lebanese ended in his death on Friday. Kidnappings from oil facilities are the favorite tactic of the militants to draw attention to their cause.

Maintenance problems in the North Sea are drawing to a close and production should be resumed shortly. That will take the pressure off the price of Brent light crude.

In the U.S. four refineries were in the process of restarting last week after being shutdown for various reasons. The Exxon Beaumont TX, Exxon Baytown TX, BP Whiting IN, and BP Carson CA were all being restarted. Successful restarts will further pressure gasoline prices through greater production.

Total S.A. terminated their force majeure declared earlier in the week on its 240,000 bpd production facility in Angola.

Saudi Arabia is expected to increase output by 240,000 bpd next week. This output had been shutdown at the Ras Tanura terminal due to a fire four weeks ago.

On the demand side the vacation-driving season has about 4-weeks left but demand hit a new record of 9,710,000 bpd of gasoline last week. China also reported that crude imports surged +12% in Q2.

Add all these facts together and stir briskly and you may get $80 oil but once gasoline prices start down again I think the high oil prices are going to crumble unless a hurricane appears.

Last week saw stock prices begin to roll over beginning with the refiners as the leading indicator that crude prices were about to weaken. We raised the stops last weekend and were rewarded with exits on several positions. I am raising stops again on those we have left and adding a couple more short-term puts.

Most news commentators don't understand the pressures futures expirations put on prices. The August crude contract terminated trading on Friday at the $75.53 close. Monday the September contract will become the current month and we could see some additional volatility as a result. I believe a lot of the upward pressure last week was short covering the expiring contract. It will be interesting to see what the new contract does next week.

I mentioned the IEA Oil Market Report last week and several readers asked for a link to the report. Your wish is my command.

Just remember that the IEA is very optimistic and has even criticized themselves recently as being overly optimistic over the last 5-years. They are making progress towards being more realistic but it may take a couple more years to bring them closer to reality.

Last week another report surfaced called "Facing the Hard Truths about Energy" and it was immediately criticized as being a whitewash for the administration. Energy Secretary Sam Bodman requested a comprehensive review of the current and future energy outlook. Dozens of "experts" and oil company officials were contracted for input. In the end the National Petroleum Council produced a report that hinted at hard truths but never clearly identified them. One commentator charged, "asking the NPC to analyze Peak Oil is like asking the tobacco industry to forecast lung cancer." The same NPC was asked to study natural gas trends in the late 1990s. Their report in 1999 predicted stable prices and soaring production. We obviously know now that exactly the opposite occurred with prices spiking to over $12 from the $2 in 1999 and production slowing for the last 5 years. I won't go into the full rebuttal but here is a link to one that is excellent.

Amazing risk of the week: Devon (DVN) said it was planning on spending $100 million to drill an exploration well 33,000 feet below the seabed near last year's Jack 2 discovery. Devon said there was about a 65% chance it would be a dry hole. They decided to take the risk because "it was only a step away from other successful wells." How you define successful would be an issue here. Nobody has decided hot to produce oil from the Jack 1 and 2 wells yet with the extreme depth the biggest issue.

Quote of the week: Boone Pickens on CNBC, "I think you are going to see $80 a barrel before I am 80." Pickens turns $80 in May 2008. Seems like a safe bet.

Long-range weather forecasts predict that a ridge of high pressure will form over the US east coast by late July. This would create the hurricane steering pattern much like the 2004 and 2005 seasons. This poses increased risk for the Gulf oil patch if it does occur. Unless it occurs soon it may not be soon enough to halt a crash in prices.

Due to reader requests I added a column to the portfolio page to show the stop losses for each position. Thanks for the suggestion Ira.

Jim Brown

August Crude Futures Chart - Weekly

August Gas Futures Chart - Daily

August Gasoline Chart - RBOB Daily


Changes in Portfolio

New Energy Plays
CVX $92.12 Chevron Put
TSO $54.38 Tesoro Put

New Non-Energy Plays
None ahead of earnings

Dropped Plays

New Watch List Plays Triggered


Portfolio Listing & Top Picks

New Plays

Most Recent Plays

CVX - $92.12 - Chevron Put

This is simply another hedge play to capture any decline in oil prices over the next couple months. Chevron will report earnings next Friday and they are the least favored of the three major US firms. (XOM, COP and CVX). The stock has found resistance at $94 and a decent decline in oil prices could knock it back to $80. This is nothing against Chevron just a short-term trade in hopes of making a profit. Should they trip over their earnings report we will be there to profit from it.

Buy Dec $90 Put CVX-XR currently $4.70, Stop loss $95.50


TSO - $54.38 - Tesoro Put

Tesoro has declined to support after failing to move higher over the last three months. TSO had a huge run from $32 to $65 (post split) between January and May. They split 2:1 in late May and lost their momentum as gasoline prices slowed their rise. I believe TSO could break support at $53.50 and fall significantly if gasoline prices continue to drop. This is a short-term play and has nothing to do with the quality of Tesoro as a refiner.

Buy Nov $50.00 PUT TSO-WJ currently $3.50, stop TSO $62


Play Updates

Existing Plays

XLE - $74.00 - Oil Drop Hedge Put *** Stop Loss $75.50 ***

The XLE declined to hit our entry target of $72 at Wednesday's open and then immediately rebound with oil to a new high on Friday. I set a stop loss at $75.50

Breakdown trigger: $72, hit 7/18

Buy Dec $70 Put XBT-XR @ $3.00

Initial profit target: XLE $67, secondary target XLE $64


RIMM - $230.50 +2.98 - Research in Motion

RIMM finally moved over our upper call strike putting us fully into the money but we have a long time until this premium decays. Our target is a $30 profit once the premium decays on the $230 call. RIMM is up +62 since our entry. RIMM has now surpassed Motorola in market cap. The RIMM President and CEO thanked Apple last week for helping to grow their BlackBerry business. Lazaridis said the whole industry benefited from the iPhone buzz from the announcement to the delivery. He credited Apple for helping them add 1.2 million customers in the quarter before the iPhone was delivered.

For initial commentary see the July 1st newsletter.

Earnings schedule: Sept 27th.

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


NOV - $117.70 +5.85 - National Oilwell ** Stop Loss $115.00 **

No news for NOV but new highs are made almost daily. Earnings are Wednesday. I raised the stop again to take us out with a profit should oil crash or NOV stumble over earnings.

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


GSF - $74.74 +1.69 - GlobalSantaFe *** Stop Loss $71 ***

GSF rebounded sharply after reporting that their worldwide SCORE (Summary of Current Offshore Rig Economics) jumped +2.4% for the month to 133.2. The SCORE base was established at the top of the 1980-81 peak of the offshore drilling cycle. The peak was set as 100 and a SCORE over 100 means drilling today is more profitable than the 1981 peak. This announcement fired up the drillers and Schlumberger's earnings on Friday helped fuel the flames.

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


CNQ $73.44 +2.67 Canadian National Res ** Stop Loss $70.00 **

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


NOK - 29.28 -0.63 Nokia *** Stop Loss $28.50 ***

Nokia floundered after Motorola and Erickson disappointed on earnings. Motorola's are not until August 2nd but we may not be around by then. I pegged the stop to take us on any further weakness. No reason to stick around if the sector is going to tank.

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


BRS - $51.80 -1.26 Bristow Group ** Stop Loss $50.50 **

Bristow gave up its gains and retreated from the new high set on Monday. No news and 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


MDR - $91.37 -0.72 - McDermott Intl ** Stop Loss $88 **

Barrons said nice things about MDR last weekend and the stock hit a new high on Monday only to stall the rest of the week. The earnings date was announced for August 8th. I raised the stop loss just in case.

For initial commentary see June 17th newsletter

Earnings schedule: August 8th

Breakout trigger: $78.00 Hit 6/11

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


HOS - $40.37 +1.27 - Hornbeck Offshore *** Stop $39.50 ***

No news on HOS other than the announcement of an earning date but the rebound continued. A new high was reached on Friday at $42. I raised the stop again to take us out on any future weakness.

For initial commentary see June 10th newsletter

Earnings schedule: August 2nd

Breakdown trigger: $39.00 hit 6/08

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


HDY - $2.89 -0.09 Hyperdynamics Corp *** Stop Loss $2.75 ***

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. It was expected to become a special law by the end of last week but it has not happened yet. We continue to wait. I did add a stop loss.

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


TSO - $54.38 -4.82 - Tesoro *** Stopped $56.50 ***

The TSO weakness turned into a rout and we were stopped out at $56.50 on the 17th. Once the price fell below our strike at $60 the profit eroded quickly. I am pushing the stops higher on the other plays to avoid this profit shrinkage.

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 stop 7/17 $9.60
Post split: (2) 2009 $60 LEAP Calls ZGC-AL @ $8.34
Exit $9.60 on 7/17 for $1.26 profit x 2 post split or $2.52.


ATW $68.90 -2.44 - Atwood Oceanics ** Stop Loss $67 **

ATW got whacked again with a sharp drop on Tuesday. No news but I did add a stop loss just in case this continues.

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


BHP - $67.03 -0.93 BHP Billiton *** Stop Loss $64.50 ***

BHP is consolidating around $66 and taking a well deserved rest. Reportedly BHP passed on the idea of buying Alcoa at its huge premium due to rumor news. Freeport McMoran was rumored to be a takeover target but there was no confirmation. The rumor mill is very active in this sector. I added a stop loss

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


CCJ - $46.94 -3.71 - Cameco *** Stopped $47.50 ***

It appears hell does have cold days. Uranium prices fell for the second consecutive week after nearly two years of constant rises. Uranium producers quickly felt radioactive as investors dumped them. We were stopped out on Tuesday for a nice profit.

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
Exit 7/17 @ $13.70, profit of $5.90


PTR - $154.28 -4.50 - Petrochina *** Stopped $152.50 ***

Tuesday's -$4 opening drop took us out of this very profitable position. It was time and we should be celebrating instead of whining. We entered the position for $10.70 back in March, (8.45 after the cost reduction play) and had you exited on the stop that LEAP was worth $40.90. Not a bad payday.

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, exit $40.90 7/18
Cost reduction 4/19 $10.70 -2.25 = $8.45
Exit 7/18 @ $40.90 for profit of $32.45 !!

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


CHK $36.49 +0.17 - Chesapeake Energy ** Stop loss $34.00 **

CHK continued to rise after the Anadarko deal on no further news. CHK is confounding the gas skeptics with its continued gain. I left the stop at $34. If stopped DO NOT close the put. 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


MRO $61.26 -3.78 - Marathon Oil *** Stopped $61.00 ***

MRO finally caved in to the refiner pressure on Friday and triggered our stop for a very nice profit. We entered the position at $6.62 (post split) and exited the play at $61 when the option was trading at $19.20. We had two options post split doubling the profit.

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 Ex $19.70 7/20
Exit 7/20 for $19.70 and profit of $13.08 x 2 = $26.16

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


SLB $96.68 +7.04 Schlumberger *** Closed $94.00 ***

Outstanding! SLB beat the street by a mile, $1.26 vs estimates of 95 cents. Strength in their worldwide business offset weakness in gas drilling in North America, especially Canada where BHI took a beating. Profits were up +47%.

I am closing SLB at this level and taking profits. We have several service companies reporting earnings next week and we have already seen a warning from BHI. If Haliburton stinks up the sector on Monday we could give back a lot of our profits waiting for a stop. We had a nice run and a fitting finish. Take profits and relax.

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
Exit 7/22 @ $34.00 for profit of $22.35

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

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


SUN $76.24 -7.81 - Sunoco *** Stopped $81.00 ***

I am sure glad I raise that stop last week to $81. Once refiners started to fall it was a sharp drop for SUN. We got out at the beginning of the drop and did not wait around for the bottom. We had been in that position nearly a year and time decay and a couple of hits from put insurance along with the $5 drop early in the week knocked our profits back to just over $2 but at least it was a profit.

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 7/17 $19.10
Exit 7/17 @ $81 stop, $19.10 for profit of $2.35

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

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

Non-Energy Positions

BZH - $19.62 -4.00 - Beazer Homes *** STOP LOSS $23.00 ***

Earnings are next Thursday and investors are fleeing like rats deserting a sinking ship. Fears of revelations with earnings and the continued implosion in the housing sector has finally knocked BZH back to the teens. We entered this position back in March and suffered through two "bottoms" in the homebuilders while waiting for the eventual crash. I will probably revise the stop on Wednesday just in case Beazer says something positive in Thursday's earnings. I just want to trail it down with hopes of seeing single digits but at this point I don't want to give back profits. This is a put not a leap.

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


New Watch List Entries


Current Watch List

UPL - Ultra Petroleum

UPL paused in its rebound and rumors have drilling slowing in the Pinedale area waiting for the new Rocky Mountain pipeline to be completed. Maintain the entry target.

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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