Option Investor

Weekly Newsletter, Sunday, 07/29/2007

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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

Nearly Perfect Entries

When I added those puts over the last two weeks I thought I might have to wait until next week before seeing any real decline. I positioned us earlier than I was planning because of the spike in crude to the same highs we saw last July but with crude inventory levels now at ten-year highs. Gasoline was falling as expected and the stage was set for a crude decline in August. I am sure glad we took the entries last week.

The plan did not work out exactly as expected although I was pretty confident when crude fell back to $73 on Tuesday that the plan was unfolding just a little ahead of schedule. When the Globex trading platform went offline for 80 minutes on Wednesday all hell broke loose. Unable to see their positions when the platform went down thousands of traders panicked and called in their buy orders to avoid being trapped in a short position and unable to execute orders. 80% of all crude contracts trade electronically. The Nymex reverted back to a manual ticket system and the pit was flooded with buy to cover orders. This started a chain reaction rebound. When Globex came back online those traders sitting in the dark suddenly found themselves racing to cover shorts squeezed by the outage. The rebound short squeeze continued to produce a +$2 gain before the close and news powered it higher overnight. $77.24 was the Thursday high before the market implosion knocked $2 back off the price. Friday saw another move higher on no news and shorts again raced to cover. The market reporters kept talking about volatility returning to the equity markets but the real volatility was in crude.

Nobody really knows why crude prices are moving higher. There is no rational explanation and nothing on the global news front to power the move. The IEA continues to pound its new shortage drum but nobody is listening just like nobody listened when they said there was plenty of oil until 2030. OPEC has no incentive to raise production because global inventory levels are still rising. The momentum players seem hell bent to push prices to $80 and after Friday's rebound they might just make it.

My view was always for the highs to be put in place at the end of July and the beginning of August. Then, assuming there are no hurricanes in the Gulf of Mexico we would see a normal decline into September on lower gasoline demand and falling gasoline prices. So far everything is following the script almost exactly and as of Friday night there are no hurricanes on the horizon. I hate to think where prices would go if a storm appears west of Cuba over the next week or two.

Crude inventories in the U.S. are now 13.5% over the 5-year average and that should be very bearish on prices. Tanker tracker Petrologistics said OPEC output was set to rise +300,000 bpd in August as cheating on quotas grows due to the high prices. Even Iran said they would increase production if needed. OPEC said last week $65 was a reasonable price for crude and that was seen as a potential level that OPEC would support by raising output. If prices are too high it drives rapid exploration. Too low and exploration slows. OPEC seems to be thinking $65 is the Goldilocks price where they are still in control, drilling is stable but not hectic, demand does not slow and OPEC revenues are stabilized. This should have a calming effect on prices but nothing has slowed yet.

Gasoline inventories are declining slower than normal and refinery utilization is finally rising steadily. Crack spreads are back to 21 cents per gallon and well off the $1 per gallon we saw earlier this year. That is still $8 per barrel but well off the $40 they were getting when the spread was a buck. Refinery utilization rose to 91.7% compared 92.5% last year. There is nothing in the data to support higher crude prices.

For the last several weeks I have been raising stops on our existing positions in anticipation of the late July, early August decline. I wanted us to stop out for a profit at the highest possible level. Historically stock prices tend to weaken before crude prices in anticipation of the normal decline in crude. This year was no exception.

However, we got an added assist from the broader market dump and some high profile earnings challenges in several energy stocks. We were stopped out of all but two energy longs and we closed SLB and GSF prior to hitting the stops. All in all it was a very successful exit with most positions very profitable.

If you have been a reader of the LEAPS newsletter for long you know we targeted the drop in prices last winter and then added to positions with the expectations of an exit now. So far so good! The next challenge is to re-enter our energy positions on the fall dip and spring dips and ride them back into the July highs. It may sound like a boring plan but it works very well.

Starting this issue I am going to begin adding some new watch list entries with what may seem like unreasonable targets. Once oil declines back to $60 those targets will be a lot closer and I will adjust them as needed to give us our next set of entries.

I am also going to start adding a couple more non-energy positions to keep it interesting while we wait for crude to dip.

The next few weeks may be boring while we wait for entries but bear with me. Enjoy the puts on CVX, TSO and the XLE while we wait. Beazer is not doing badly either! The object of the LEAPS newsletter is not to trade just to be trading but to trade when it is profitable. There is a difference. Last year I did press some entries and ended up paying the price trying to recoup option prices with secondary insurance puts and covered calls. I would rather just make better entries and avoid the hassle of trying to time the market on a monthly basis. I am always open to suggestions from readers so fire away if you have an idea.

Jim Brown

September Crude Futures Chart - Weekly

August Gas Futures Chart - Daily

August Gasoline Chart - RBOB Daily


Changes in Portfolio

New Energy Plays

See Watch List

New Non-Energy Plays

See Watch List

Dropped Plays

New Watch List Plays Triggered


Portfolio Listing & Top Picks

New Plays

Most Recent Plays

None this week.

Play Updates

Existing Plays

CVX - $85.20 -6.92 - Chevron Put *** Stop loss $94.50 ***

A great start for one of our crude price decline plays and crude has yet to decline. Chevron beat the street when they announced earnings last week but reported that production volume had fallen by -1% and would continue to be lower than last year for the rest of 2007. They produced the most earnings of any quarter in their 128-year history at $5.38 billion. They were rewarded for their performance with a -$2.26 drop in the stock price. Chevron benefited from the fat refining margins for the first 6-months of the year but will suffer as margins decline for the next six months. Chevron earned +21% more so far in 2007 than the first 6-months of 2006. I am leaving the stop loss high to allow for any bounces on higher crude.

For initial commentary see the July 22nd newsletter.

7/23/07 Position: Dec $90 Put CVX-XR @ $4.70


TSO - $47.89 -6.49 Tesoro Put *** Stop Loss $58 ***

Tesoro continues to implode as gasoline prices fall and crack spreads narrow. I am looking for much lower levels on TSO as the summer draws to a close. Their strong gains since January added +$60 to the price of the stock pre-split and that is a lot of profit that needs to be captured.

For initial commentary see the July 22nd newsletter.

7/23/07 Position: Nov $50.00 PUT TSO-WJ @ $3.50


XLE - $68.50 -5.50 Oil Drop Hedge Put *** Stop Loss $73.50 ***

The decline in the big oils and the market correction got us started south at a high rate of speed. Let's hope it continues. I lowered the stop loss to $73.50

For initial commentary see the July 15th newsletter.

Breakdown trigger: $72, hit 7/18

7/18/07 Position: Dec $70 Put XBT-XR @ $3.00

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


RIMM - $215.70 -14.80 - Research in Motion

RIMM gave up a lot of ground in the market drop but remains above the support at $210. Actually by retreating slightly our current profit increased because of the decline in the short call. Plenty of time before this play will close.

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 - $118.04 +0.34 - National Oilwell ** Stopped $115.00 **

That was not exactly how I would have played that if I had a crystal ball. The Tuesday drop in oil prices knocked NOV back to our stop taking us out of the play for close to a 100% profit. Wednesday's spectacular earnings jump of +$12 left us standing on the sidelines watching. Maybe someday I will learn to take a 100% profit gracefully. Until then I will kick myself for pressing this stop.

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
Exit 7/23 with stop at $115 for 19.60, +$9.10 profit


GSF - $73.40 -1.34 - GlobalSantaFe *** Closed $78.75 ***

GSF and RIG announced a merger of equals on Monday and GSF spiked to $80 on the news. Fearing a decline in our LEAP price once the excitement wore off I sent everyone an email recommending we close at the $78.75 price at 3:PM Monday afternoon. Had you exited on that email the LEAP price was $13.50. It declined by Friday on GSF's -$7 drop in price to $11. It was a good merger and a quick profit. We will play them again once they complete the merger.

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
Exit 3:00 7/23 @ $13.50, +2.40 profit.


CNQ $67.92 -5.52 Canadian National Res *** Stopped $70.00 ***

CNQ retreated from its new high at $74 and stopped us out as planned when it hit $70 on July 24th. It was a quick 30-day play and a decent profit. No regrets here.

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 @ $12.70 7/24
Exit 7/24 at $70 stop, $12.70, +3.20 profit


NOK - 27.96 -1.32 Nokia *** Stopped $28.50 ***

Nokia crashed with the market and took us out at our stop of $28.50 for a minor profit. Not exciting but better than a loss.

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
Exit 7/24 at $28.50 stop, $5.20, +0.30


BRS - $51.80 -4.14 Bristow Group ** Stopped $50.50 **

Bristow cratered on Tuesday with no news and never looked back. We exited at the $50.50 stop for a -60 cent loss.

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
Exit 7/24 at $50.50 stop, $4.40, -0.60


MDR - $79.40 -11.97 - McDermott Intl ** Stopped $88 **

That would have been extremely painful if we did not have a tight stop. We exited on Tuesday at $88 and spared ourselves a -$12 drop.

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 @ $22.40 7/24
Exit 7/24 at $88 stop, $22.40, +12.60


HOS - $42.47 +0.83 - Hornbeck Offshore *** Stop $39.50 ***

Hornbeck rallied on Wednesday on news it was buying 20 ships from Nabors to increase its fleet. This was viewed as a strong positive by the analyst community. HOS spiked $5 on the news and although it gave back some on Thursday's market weakness it is still trending higher. I expect HOS to rally strongly once the market recovers. That assume it does not trip over earnings next week.

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 - $3.13 +0.24 Hyperdynamics Corp *** Stopped $2.75 ***

This was a crazy week for HDY. On Monday news broke that Guinea was going to kick back the contract on HDY and not complete the ratification process. On Wednesday news broke that said Guinea was going to auction its offshore leases. HDY dropped to $2.32 on the news. Right at the close HDY spiked back to $2.82 on no news. On Thursday HDY issued a press release saying Guinea had sent them a letter claiming ratification of their lease could come at any time and HDY hit a new high for the month. I don't know what is fact or fiction and I would be cautious reentering the HDY play. We were stopped out at $2.75 on Monday. If HDY moves over $3.25 on real news that Guinea had approved the lease, not a HDY press release, I would consider taking a new position.

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
Exit 7/23 @ $2.75 stop, +.29


ATW $68.77 -0.13 - Atwood Oceanics ** Stop Loss $67 **

So far so good. The GSF/RIG news spiked ATW to just over $75 on rumors that ATW could be another takeover target. That was nothing new to us but was good for a decent spike. The market weakness brought it back down to support at $68 and in danger of our stop if the weakness 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 - $61.34 -5.69 BHP Billiton *** Stopped $64.50 ***

BHP took a nasty hit from the decline in miners on overseas markets. Worries that the credit crunch would slow global growth and the Tuesday drop in oil prices caused BHP to trigger our exit stop at $64.50 on Thursday. I would not hesitate to reenter BHP once the market recovers.

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
Exit 7/26 at $64.50 stop, $18.90, +12.90.


CHK $33.78 -2.71 - Chesapeake Energy ** Stopped $34.00 **

The drop in gas prices and the downgrade by Fortis pressured CHK back into our stop at $34.00. We escaped with a minor profit but still have an October $30 put active. Maintain the put position per the previous instructions. If gas prices continue to fall we could benefit from that we well.

For initial commentary see Dec-9th newsletter.

Earnings schedule: Aug 2nd

Current recommendation: Hold

Position: 2009 $35 LEAP VEC-AG @ $5.30
Exit 7/25 at $34 Stop, $5.50, +0.20

Insurance put: KEEP OPEN
Oct $30 Put CHK-VF @ 90 cents. Profit stop $29

Non-Energy Positions

BZH - $15.60 -4.02 - Beazer Homes *** STOP LOSS $17.25 ***

Beazer posted a loss of $123 million or $3.20 per share that included charges of $188.5 million to write down inventory, goodwill and forfeited options on land. Analysts had expected a loss of -32 cents. Revenue fell -37%. Beazer said it had excess inventory in most of its markets that were forcing lower prices. It also disclosed various legal proceedings from the U.S. Attorney's office and the SEC, which had moved to formal status. Since Beazer has already admitted to firing the CFO for attempting to destroy documents relating to these cases the outcome should not be good. I had hoped to ride BZH to single digits but it failed to drop materially on Thursday afternoon or Friday. I am wondering if $15 may not be support. I am lowering the stop just in case.

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: July 26th, loss of $3.20 per share vs Est -.32

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

Leaps Trader Watch List

Dropped Entries

New Watch List Entries
JEC Jacobs Engerneering
BHP BHP Billiton
NOV National Oilwell Varco
COP Conoco Phillips
VLO Valero Energy

Current Watch List

UPL - Ultra Petroleum

$52.25, we got close and gas prices are still falling. 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


BHP - BHP Billiton

We were stopped on BHP for a nice profit and I want to re-enter the position using a longer LEAP on any further price declines.

Company Info:

BHP Billiton Limited is a diversified resources group. The Company has seven business units, or Customer Sector Groups: Petroleum, which explores for, produces, processes and markets hydrocarbons, including oil, gas and liquefied natural gas; Aluminium, which explores for and mines bauxite, and processes and markets aluminium and alumina; Base Metals, which explores for, mines, processes and markets copper, silver, zinc, lead, uranium and copper by-products, including gold and molybdenum; Carbon Steel Materials, which explores for, mines, processes and markets metallurgical coal, iron ore and manganese used in the production of carbon steel; Diamonds and Specialty Products, which explores for and mines diamonds and titanium minerals; Energy Coal, which explores for, mines, processes and markets energy coal for use in electricity generation, and Stainless Steel Materials, which explores for, mines, processes and markets nickel, which is used in the production of stainless steel.

Breakdown target: $55

Buy 2010 $70 LEAP Call LPH-AN


JEC - Jacobs Engineering Group

Jacobs has been on a very strong growth path and the recent market weakness has knocked it back into range. It has oil and gas exposure but it not an oil and gas company.

Company Info:

Jacobs Engineering Group Inc. is a professional services firm that focuses on providing a range of technical, professional and construction services. It provides project services, which include engineering, design, architectural, and similar services; process, scientific, and systems consulting services; operations and maintenance services, and construction services, which include direct-hire construction and construction management services. It concentrates its services on selected industry groups and markets, including oil and gas exploration, production and refining; programs for various federal governments; pharmaceuticals and biotechnology; chemicals and polymers; buildings, which includes projects in the fields of healthcare and education, as well as civic, governmental and other buildings; infrastructure and technology and manufacturing. In April 2006, its Canadian subsidiary acquired Techna-West Engineering Limited. In October 2006, it acquired W.H. Linder & Associates, Inc.


Breakdown target: $55

Buy JAN 2008 $60 Call JEC-AL


NOV - National Oilwell Varco

This may be wishful thinking but a major drop in crude prices over the next several months could bring NOV back into range once again.

Company Info:

National Oilwell Varco, Inc. (NOV) is a worldwide provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. The Company operates in three segments: Rig Technology, Petroleum Services & Supplies, and Distribution Services. The Rig Technology segment designs, manufactures, sells and services complete systems for the drilling, completion and servicing of oil and gas wells. The Petroleum Services & Supplies segment provides a variety of consumable goods and services used to drill, complete, remediate and workover oil and gas wells, service pipelines, flowlines and other oilfield tubular goods. The Distribution Services segment provides maintenance, repair and operating supplies, and spare parts. In March 2006, NOV acquired Soil Recovery A/S. In November 2006, it acquired Rolligon Ltd. In December 2006, it acquired 87% of NQL Energy Services Inc.

Breakdown target: $100

BUY FEB $110 Calls NOV-BB


VLO - Valero Energy

Looking to buy Valero cheap on the fall dip.

Company Info:

Valero Energy Corporation owns and operates 18 refineries located in the United States, Canada and Aruba that produce refined products, such as reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur and ultra-low-sulfur diesel fuel, and oxygenates (liquid hydrocarbon compounds containing oxygen). It also produces conventional gasolines, distillates, jet fuel, asphalt, petrochemicals and other refined products. It 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 approximately 5,800 retail and wholesale branded outlets in the United States, Canada and Aruba. During the year ended December 31, 2006, it sold all of its ownership interest in Valero GP Holdings, LLC. In July 2007, the Company sold its Lima, Ohio refinery to Husky Energy Inc.

Breakdown target: $55

BUY 2009 $70 LEAP Call VHB-AN (*** LEAP MAY CHANGE ***)


COP - Conoco Phillips

I hesitate to add Conoco because of its Russian LUKOIL exposure but the company is doing everything else right. Now that it is out of Venezuela it should be more aggressive with other opportunities.

Company Info:

ConocoPhillips (ConocoPhillips) is an international, integrated energy company. The Company's business is organized into six segments. Exploration and Production segment primarily explores for, produces and markets crude oil, natural gas and natural gas liquids on a worldwide basis. Midstream segment gathers, processes and markets natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids, primarily in the United States and Trinidad. Refining and Marketing segment purchases, refines, markets and transports crude oil and petroleum products, mainly in the United States, Europe and Asia. LUKOIL Investment segment consists of its equity investment in the ordinary shares of OAO LUKOIL (LUKOIL). The Chemicals segment manufactures and markets petrochemicals and plastics on a worldwide basis. Emerging Businesses segment includes the development of new technologies and businesses outside the Company's normal scope of operations.

Breakdown target: $70

Buy 2010 $80 LEAP Call YRO-AP


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