Option Investor

Weekly Newsletter, Saturday, 03/22/2008

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing & Top Picks
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Bear Market In Oil

Amazing how quickly bubbles can burst. The +$11 ramp in oil prices to $111 over just the last two weeks saw a massive reversal as the April crude contract expired. I discussed last week how there were 18 times more April contracts than Cushing had storage to hold the deliveries. The vast majority of those contracts would have to be sold and settled in cash because the open interest was many times over what actual buyers in the spot market would be able to consume. Most refiners have established contracts for crude well in advance of delivery. They only go to the spot market when they need a more than they have coming contractually or when there is an interruption somewhere else. The resulting sell off in crude last week knocked -8.30 off the price with Thursday's close at $101.70 after trading as low as $98.65. That brought oil prices back to decent support at $100 and a logical place to rest. 29 of 34 analysts surveyed by Bloomberg felt that oil prices would continue to fall through March 27th.

The sector rotation out of commodities hit not only oil buy metals, grains, lumber, etc. Somebody rang the exit bell on the month long rally and it was a race for the exits. The CRB Index of 19 commodities fell -8.3% for the week and the largest weekly drop since 1956. Is it permanent? Are we going to give back all the gains for the last six months? I seriously doubt it. Global growth could easily slow by several percent and there would still be a shortage of commodities. Traders are simply taking profits after a long run and rotating into other sectors. Banks, brokerages, finance and insurance suddenly look like bargains given the recent Fed actions. Another factor feeding the sudden decline is margin calls. Michael Smith of T.K. Futures said there was a lack of liquidity in the markets and funds were selling raw-material futures to raise cash to cover margin calls. When futures contracts decline they require more money on deposit to maintain the position.

The oil inventory report on Wednesday showed oil levels stayed the same but gasoline inventories plunged for the first time in 18-weeks with a -3.4 million barrel plunge. There was such a panic sell occurring in commodities in general that the number was completely overlooked. The key point was the drop in refinery utilization to 83.8% and the lowest level since March-2006. There is so much gasoline in the system that refineries are opting to either shutdown for maintenance or cut back on runs to avoid increasing supplies above their record levels. Price at the pump is definitely having an impact on consumer buying habits. The Energy Department said gasoline demand dropped by -1% last week alone.

Weekly Oil Inventory Report

National gasoline prices slipped slightly to $3.275 per gallon but diesel continued to climb to top $4.03 per gallon and a new record. A reader reported to me this week about conditions inside a trucking company where he has connections. Reportedly with the price of diesel going up daily they are not breaking even despite the fuel surcharges. The rate of increase has been faster than the surcharges can compensate. Even worse he reported a sharp slowdown in durable and capital goods being hauled. He warned me to expect earnings problems for this quarter and next. Bill Zollars, CEO of YRC Worldwide, said on Wednesday that there was increased weakness from retail customers and the overall economy has not changed from the recent weakness. He also said that severe winter weather has hampered shipping even more than normal. YRCW stock spiked slightly on news that renewing YRC contracts for 2008 showed an uptick in expected weights to be shipped. Zollars said typically this pointed to a future economic recovery.

You may have heard that Exxon had an analyst meeting in early March. At that meeting they admitted that their global oil production would remain flat through 2012. That is astounding to me given the price of oil over $100 but it fits in perfectly with the peak oil scenario. Exxon said it was having trouble finding and producing more oil than they were losing in depletion of existing fields. This should have been front-page news but it garnered barely a mention in the press. Since 2000 Exxon's output from two of its largest regions, the U.S. and Europe, declined by 37%. That equates to about a 500,000 bpd drop. Depletion matters! Exxon said it was sizing up its investment opportunities based on what price they expected to get for the oil. They were taking the top of the list and had increased the capital budget to $25 billion from $21 billion in order to pursue the best opportunities. They will start 12 new projects this year. Exxon said it was also losing production due to new revenue sharing agreements with its country partners. More contracts are calling for royalties to be paid in oil and the higher the price of oil the more barrels the contracts call for as royalties. If Exxon produces 50,000 bpd from a field at $90 the royalty may be a diversion of 5,000 barrels. If the price moves over $110 then the contracts could call for 10,000 barrels to be diverted to the country. It is the global equivalent of a windfall profits tax. You make more per barrel and we get more barrels. Take it or leave it. Exxon still made a bundle with $40.6 billion in profits in 2007. Exxon invested $21 billion in exploration and $36 billion in stock buybacks in 2007. This increased the number of barrels owned by Exxon shareholders by 20%. Exxon is quickly buying itself back but it is not raising production. CEO Tillerson said "if we had investment opportunities we would pursue them" but the $36 billion in buybacks suggests there is far more money than opportunity.

Shell released reserve numbers last week and showed that the actual cost of getting the oil out of the ground had increased to $15 in 2007 compared to only $6 in 2003. Shell also disclosed that the "operating" cost of the Athabasca oil sands project was between $20-$25 per barrel. That is primarily the cost of natural gas to heat the sands and make the oil flow. They would not disclose the "capital" cost per barrel but that is estimated to be between $15-$20 per barrel. The Shell CEO is tough to believe. In one press conference he says demand will exceed supply by 2012. In another press event he says the idea of peak oil is ridiculous. Granted demand exceeding supply is not peak oil but it will have a similar impact on prices. He thinks we are suddenly going to unlock the estimated trillion barrels in oil shale and another trillion in oil sands that cannot be mined in the current sense. Unfortunately neither of those represent any material flows and neither will come to market within the next ten years even if the technology was discovered tomorrow.

Barclays raised its crude price forecast for 2008 to $100 a barrel and the second increase in less than a month. They blamed lowered estimates of non-OPEC supply for the increase. Merrill boosted its 2008 forecast last week to $102. Barclay's analyst said "perceptions about the sustainability of $100 per barrel" are gaining a greater level of acceptance. "Demand growth is robust and non-OPEC supply is "disappointing dramatically." Remember, Goldman said the prior week that we could see explosive rallies to $175 as political decisions on money flows, labor and technology are "substantially constraining supply growth."

Wood MacKenzie Consultants said global demand will grow by about 10 mbpd by 2012 assuming there is not a major recession. They feel OPEC will need to increase production by 3 mbpd and the rest will have to come from non-OPEC suppliers. When taken in context with the prior paragraph about non-OPEC supply "disappointing dramatically" it makes you wonder if they were on drugs when they issued the forecast.

The combination of the Monday and Wednesday drop in the broader market and the implosion in commodities and anything related completed the house cleaning in the portfolio. We were stopped out on all but one energy position. With oil prices expected to decline even further there is little reason to rush back in. I will start adding targets to the watch list but I want to be selective. Typically oil begins to climb heading into summer demand and the hurricane season but with prices and inventories so high it remains to be seen if the normal cycle will appear. We did have one new entry in Tenaris.

Jim Brown

May Crude Futures Chart - Daily

April Natural Gas Futures Chart - Daily

April Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays


New Non-Energy Plays


Dropped Plays

New Watch List Plays Triggered
TS $45.08 Tenaris

Portfolio Listing & Top Picks

Top Picks

If you are looking to add another position this are my top picks for this week. The target prices listed would be the ideal entry points for these stocks today. There is no assurance any stock will ever return to these support levels and you will need to make your own decision about an entry point above these levels. I believe these stocks have the best potential this week. The list will change from week to week based on technicals, fundamentals, crude prices and market action. The list is not sorted in any particular order.


Only four plays left and I would buy them all on any positive market movement next week.

The yellow means they are very close to those entry levels and green means they are at the target level.

New Plays

Most Recent Plays

New Watch List Plays Triggered

TS $45.08 - Tenaris

Tenaris is a global manufacturer of pipe used in oil and gas drilling and infrastructure. Business is not expected to slow. We saw a -$6 drop for the week and that triggered our entry at $46 on Wednesday.

Company Info

Tenaris S.A. (Tenaris) is a holding company. The Company, together with its subsidiaries, operates as a global manufacturer and supplier of tubular products and services used in the drilling, completion and production of oil and gas, and a supplier of tubular products and services used in process and power plants, and in specialized industrial and automotive applications. It has three major business segments. The Tubes segment includes the operations that consist of the production and sale of both seamless and welded steel tubular products and related services mainly for energy and industrial applications. The Projects segment includes the operations that consist of the production and sale of welded steel pipe products mainly used in the construction of major pipeline projects. The Others segment includes the operations that consist of the production and sale of sucker rods, welded steel pipes for electric conduits, industrial equipment and raw materials, such as hot briquetted iron

Breakdown trigger: $46.00 hit 3/19

Position: SEP $50 Call TSW-IJ @ $3.40


Play Updates

Existing Plays

MDR $49.13 -2.77 McDermott Intl *** Stopped $49.00 ***

Even after a very bullish conference call on March-20th the market worked its magic and took us out of MDR. I am reentering above $51.

Jan-09 $60 LEAP call OYZ-AL @ $6.90, exit $6.00, 3/17


UNT $52.95 -2.50 Unit Corp *** Stopped $53 ***

No news, bad market, ugly stop.

Breakout trigger: $52.00 hit 02/04

Position: Sept $55 Call UNT-IK @ $3.80, exit $3.70, 3/20


FLS $99.63 +3.44 Flowserv *** Stopped $94 ***

On a week where Flowserve gained $3.44 we were stopped on Monday's opening dip. There is no justice.

Breakdown trigger: $77.50, hit 1/22

July $90 Call FLS-GR @ $6.00, exit 13.40, 3/17 +7.40


FLR $131.13 -5.41 - Fluor Corp *** Stopped $130 ***

A $15 drop on Monday wiped us out but FLR rebounded +20 on Tuesday. That was followed by an $18 drop on Wednesday. To say the volatility in FLR is huge would be an understatement. If you took the remediation position back in January you are still ahead on that spread and I would continue to hold those positions.

Earnings: Feb 28th +$2.82 with items vs street $1.18

Breakdown trigger: $145 Hit 12/13

Position: 2009 $160 LEAP Call XOB-AL @ $22.30, exit $13.70, 3/17

Remediation plan: 1/20
LONG: April $110 Put FLR-PB @ $9.20
SHORT: Jan $170 LEAP Put XOB-MN @ $58.40


RIG $131.14 -6.41 - Transocean Inc ** Stopped $130 **

Continued news of shortages in the deep water drilling market and RIG rolled over instead. It was a case of the outgoing tide taking everyone lower.

Earnings: Feb 20th, +70%

Breakdown trigger: Hit 12/4 @ $130

Position: 2009 $140 LEAP Call VOI-AH @ $15.80, exit $17.10, 3/17


CLB $111.41 -10.99 Core Labs *** Stopped $115 ***

CLB had held up pretty well for weeks but the bottom fell out on Wednesday on no news. Bad market and sector rotation killed us.

Earnings: $1.36, +39%.

Breakdown Trigger: $130 hit 11/12

2009 $140 LEAP Call ZYM-AH @ $21.30, exit $8.50 (est) 3/19

Remediation addition:
Position: June $130 Call CLB-FF @ $6.10, exit $3.40, 3/19


HP $43.20 -2.71 Helmerich & Payne *** Stop Loss $41 ***

HP dipped with the market but remained over the stop. Stifel Nicolaus upgraded them to a buy on the 18th.

Earnings: Jan-31st $1.02

Position: Jan 2009 $35 LEAP Call ZQA-AG @ $4.50

Insurance put:
Position: Nov $30 HP-WF. @ .50, expired

Non-Energy Positions

C $22.50 +2.72 - Citigroup

Citi is rocking now. The Fed actions seem to have given the sector a solid boost that suggests the bottom is behind us.

Position: 2010 $25 LEAP Call WRV-AE @ $4.00

Position: June $17.50 Put C-RR @ $1.25


TEX $58.89 -7.69 Terex Corp *** Stopped $59.00 ***

Recession fears crushed the machinery sector and TEX was the lead player.

Earnings: Feb 21st, +72%, +27% in revenue

Position: Jan 2009 $70 LEAP Call VXQ-AN @ $8.60, exit $8.20, 3/20

Covered LEAP Calls

AAPL $133.27 +6.66 Apple Inc *** Covered LEAP Call ***

Looks like a launch! We still have some resistance to cross but aggressive players could start adding some speculative calls here.

When Apple starts to post a new positive trend we will do a put spread to recover some more money. First we wait for the trend.

Long: AAPL @ open of $177.52 (Jan-14th open)
Short: 2009 $150 LEAP Call VAA-AW @ $20.80
Breakeven: AAPL @ $136.12

Position changes:
Closed $200 LEAP Short @ $9.40 ($30.00 - 9.40 = gain +20.60)
Replaced with $150 LEAP short @ $20.80
AAPL cost basis $177.52 - $41.40 (20.60 + 20.80) = 136.12
Breakeven: AAPL @ $136.12


RIMM $104.94 +3.25 Research in Motion - Stop Loss $80

Still cautious on RIMM but it looks like resistance at $105 is about to break.

See the Jan-13th LEAPs newsletter for the description of the change in the options.

Alert entry 11/12 @ $102.600

Covered LEAP Call:

LONG RIMM @ $102.60 (cost $102.60 -9.10 $150 LEAP = 93.50)
SSHORT 2009 $110 LEAP Call VHO-AB @ $18.30 on 1/14/08

Closed: 1/14
SHORT 2009 $150 LEAP Call XTB-AJ @ $18.50, close $9.40 +9.10

Leaps Trader Watch List

Dropped Entries


New Watch List Entries
MDR McDermott Intl
GRMN Garmin
SPWR SunPower
CY Cypress Semi
TOL Toll Brothers
PBR Petrobras
USO U.S. Oil Fund

Current Watch List

MDR - McDermott Intl

On McDermott's conference call they said they were expecting to announce "several" $1 billion contracts over the next 90 days and a "lot" or $100-$300 million awards. This is the most in the company's history. They already have a $9.8 billion backlog.

Company Info

McDermott International, Inc. is an engineering and construction company with specialty manufacturing and service capabilities and is the parent company of the McDermott group of companies, including J. Ray McDermott, S.A. (JRMSA) and The Babcock & Wilcox Company (B&W). The Company operates in three business segments: Offshore Oil and Gas Construction, Government Operations and Power Generation Systems. On July 27, 2007, the Company acquired Secunda International Limited. On May 1, 2007, it acquired Marine Mechanical Corporation.

Breakdown trigger: $46.00

Buy 2010 $50 LEAP Call YAE-AJ
Sell 2010 $65 LEAP Call YAE-AM

Breakout trigger: $51.00

Buy 2009 $55 LEAP Call OYZ-AK
Sell 2009 $75 LEAP Call OYZ-AO


GRMN - Garmin

I believe the worst is over for Garmin and I am a firm believer in their products having driven over 20,000 miles on a NUVI 660. They appear to be trying to rebound out of their disaster and over $63 could gain some traction.

Company Info:

Garmin Limited (Garmin) is a global provider of navigation, communications and information devices, which are enabled by global positioning system (GPS) technology. Garmin designs, develops, manufactures and markets a family of hand-held, portable and fixed-mount GPS-enabled products and other navigation, communications and information products for the automotive/mobile, outdoor/fitness, marine and general aviation markets. The segments of the Company are Marine, Automotive/Mobile, Outdoor/Fitness, and Aviation. In January 2007, Garmin acquired location-based services provider Digital Cyclone Inc. (DCI). DCI markets location-based services, including weather solutions for consumers, outdoor enthusiasts, and pilots on a subscription- based model in partnership with national wireless carriers and regional carriers

Breakout trigger $63.00

Buy 2009 $70 LEAP Call VWM-AN
Sell 2009 $100 LEAP Call VWM-AT


SPWR - SunPower

Is the worst over in the solar sector? Nobody knows but SPWR has been trying to bottom at $60 since mid-January. If it ever catches fire again it could be a fast ramp. Every day brings us closer to a solar revolution and SPWR is leading their portion of the sector. If we do get a bounce over initial resistance we will enter a speculative call spread to reduce our cost.

Company Info:

SunPower Corporation (SunPower) is a vertically integrated solar products and services company that designs, manufactures and markets high-performance solar electric power technologies. Its solar power products are sold through its components business segment, or its components segment. In January 2007, it acquired PowerLight Corporation PowerLight, known as SunPower Corporation, Systems (SP Systems), which developed, engineered, manufactured and delivered large-scale solar power systems. These activities are performed by its systems business segment, or its systems segment. Its solar power systems, which generate electric energy, integrate solar cells and panels manufactured by it, as well as other suppliers. It operates in two segments: components segment and Systems segments.

Breakout trigger: $66

Buy 2010 $80 LEAP Call LMO-AP
Sell 2010 $130 LEAP Call LMO-AW


CY - Cypress Semi

Cypress is another way to play the solar sector. They are a major owner of SPWR and will likely sell off their ownership of SPWR in 2008 according to analysts. The value of their SPWR holdings is more than the entire market cap of Cypress.

The volatility is much lower on Cypress than SunPower and those looking for a safer play should consider this position instead of SPWR.

Company Info:

Cypress Semiconductor Corporation (Cypress) is a broad-line semiconductor company. The Company delivers mixed-signal, programmable solutions. Its offerings include the Programmable System-on-Chip (PSoC) products, universal serial bus (USB) controllers, general-purpose programmable clocks and memories. Cypress also offers wired and wireless connectivity solutions. Cypress serves numerous markets, including consumer, computation, data communications, automotive and industrial. As of December 30, 2007, Cypress operated five business segments: Consumer and Computation Division, Data Communications Division, Memory and Imaging Division, SunPower Corporation (SunPower) and Other. During the fiscal year ended December 30, 2007 (fiscal 2007), SunPower completed the acquisition of PowerLight Corporation (PowerLight), known as SunPower Corporation, Systems.

Breakout trigger: $21.50

Buy 2010 $25 LEAP Call WSY-AE


TOL - Toll Brothers

Last week's Fed action has built a fire under the homebuilders. The capital changes on FNM/FRE could add $200 billion to the mortgage market and if they follow through with plans to raise additional capital and buy mortgage backed securities that number could rise to $1 trillion. That should be enough to keep that fire going. CEO Robert Toll bought 250,000 shares on March 12th.

Company Info:

Toll Brothers, Inc. is engaged in designing, building, marketing and arranging finance for single-family detached and attached homes in luxury residential communities. The Company is also involved, directly and through joint ventures, in projects where it is building, or converting existing rental apartment buildings into high-, mid- and low-rise luxury homes. During the fiscal year ended October 31, 2007 (fiscal 2007), the Company delivered 7,023 homes from 385 communities. In fiscal 2007, the Company has introduced 70 new single-family detached models, 28 new single-family attached models and 32 new condominium units. The four segments operated by the Company includes the North, the Mid-Atlantic, the South and the West.

Breakout trigger: $25

Buy 2010 $30 LEAP Call YKW-AE


PBR - Petrobras

This company has everything going for it and there is no reason for this decline other than sector rotation. If we see $90 on a dip we need to be buyers.

Company Info:

Petroleo Brasileiro SA - Petrobras (Petrobras) is a Brazil-based holding company engaged in the exploration, production, refinement and distribution of oil and gas. The Company is involved in four business areas: Exploration and Production, Downstream, Gas & Energy and International. Petrobras has 109 production platforms and 15 refineries. It operates 31,089 kilometers of pipelines. The Company has various subsidiaries: Petrobras Quimica SA - Petroquisa, which is engaged in the production, commercialization, distribution, import and export of chemical products; Petrobras Distribuidora SA - BR, which is involved in the distribution and commercialization of oil products and natural gas, and Petrobras Netherlands BV - PNBV, which is active in the purchase, sale and rent of equipment and platforms for the production of oil and gas. Petrobras operates in Brazil, Argentina, Mexico, Portugal, the United States, Peru and Turkey, among others.

Breakdown trigger: $90

Buy 2010 $100 LEAP Call YMO-AT
Sell 2010 $140 LEAP Call YMO-AH


USO - U.S. Oil Fund

The USO fell -$8 last week to trade under $80. If we really get some margin selling in the commodities and especially oil it is possible but not probable we could see $72. If by some freak combination of circumstances we do tag that level we want to be long.

Breakdown trigger: $72

Buy 2009 $75 LEAP Call OLL-AW
Sell 2009 $95 LEAP Call OLL-AQ


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