Option Investor

Weekly Newsletter, Sunday, 04/20/2008

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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

$117, Do I Hear $120?

May futures closed at $116.97 on Friday as news of more violence in Nigeria helped to crush the shorts for another $2 gain. There is no fundamental reason for oil to be this high but I have already said that about 117 times over the last two months. When the momentum players are in control there does not need to be a reason. It is just highly frustrating trying to pick plays on fundamentals when fundamentals don't matter.

In Wednesday's inventory report crude dipped slightly for the second week but remains well stocked. Gasoline fell another 5.5 million barrels stretching the 5-week decline to something in the 20 million barrel range. On the surface that appears very bearish but as I explained Thursday night that is due to refiners trying to flush the winter gasoline out of the system and at the same time trying not to refine the summer blends for a loss. Refinery utilization fell to 81.4% and a 16-year low. If we needed gasoline there is plenty of oil and plenty of capacity to create it almost instantly. But that would be a fundamental point that nobody cares to hear.

EIA Inventory

In Nigeria the Movement for Emancipation of the Niger Delta (MEND) said they had attacked a major pipeline feeding the Bonny export terminal. This is the largest terminal in the country with storage for 7 million barrels of oil. There was no report on the extent of the damages but any sentence that contains the words attack and pipeline is good for a $2 spike in oil prices. Nigeria has had over one million barrels of oil per day shut in for most of the last year due to violence. The group wants a share of the oil revenue to cease their attacks. Nigeria is the 3rd largest importer to the U.S. of light sweet crude.

Gasoline prices hit $3.418 per gallon on Friday and a new record. No surprise there. Many states are reporting prices over $3.65 with the west coast around $4. I explained the reason for the price spike in May in Thursday night's email. Basically for those that did not see it the gasoline blends change on May 1st to conform with EPA rules. During the winter refiners can sell generic gasoline to any region. Beginning on May 1st each region requires a specific blend to reduce heat evaporation and emissions. The gasoline must be blended with other ingredients like ethanol to comply with the rules. It becomes branded for a specific region and the cheaper generic blend goes away. Without the generic competition the refiners can get more for their products and dealers have to buy from a specific source to meet the rules.

The drop in gasoline inventories is due to one thing. The gasoline in the system on May 1st must conform to the May blend requirements. All generic winter gasoline must be out of the system. With demand down the only way to flush the system is to put very little gasoline in it. With consumption around 9 mbpd it would take 24 days to drain the system. Of course we can't afford to actually drain it and start over so the refiners are only putting in the bare minimum gasoline needed to keep everything flowing. They are now putting in the more expensive summer blend to flush out the remaining winter supplies. In theory on May 1st every pump will be dispensing a summer blend but I would be very surprised if it ever worked out that way.

BP announced its Thunderhorse production platform in the Gulf of Mexico would finally be online by the end of 2008. You may remember that the platform was nearly sunk by Katrina and suffered hundreds of millions in damage. BP said it would be a powerful symbol of a change in the BP philosophy when it begins operation. BP said it would be one of 25 projects that would come online between 2007-2009 that would add 650,000 bpd of new production.

The new projects would continue through 2012 with projected total BP production of 4.3 mbpd. Looking forward the CEO said BP was committed to maintaining that 4 MBPD production until at least 2020. BP is changing its business model, again. They have decided to sell their retail outlets in the U.S. and numerous other non-core assets to focus on only two things. Those are Exploration and Production and Refining and Marketing. They plan to cut corporate overhead by 15-20% by laying off management and eliminating unnecessary internal processes. BP has been criticized for the last couple years for being in a "run out" phase. That means they were not growing and were focused on simply producing existing reserves and buying back stock as the company grew smaller. This suggests they have found a backbone again and are going to try and survive in the competitive climate. BP claims it has secured new opportunities in Algeria, Oman, Libya, Colombia, Pakistan and in Canadian heavy oil. They remain under the gun in Russia where they are one of the few "partners" that have remained partners and not slaves. They operate the TNK-BP field. Maybe it is time to rethink a play on BP.

I think we are getting close to an entry point on some energy plays. If the May crude futures expiration follows the trend of the April expiration we could have a significant drop in oil prices by next Friday. May futures expire on Tuesday. In the April cycle in March the price of crude fell -$10 within 48 hours after expiration. The CFTC said open interest in crude futures rose 40% over the last two weeks and that suggests a lot of new short positions. Those May positions will have to be closed by Tuesday.

May Crude Futures Chart - Daily

"Deathanol" may finally be on its last legs as a mass-produced biofuel from corn. 33 countries are experiencing food riots and we are burning corn for fuel. This has not escaped notice of many nations and the U.S. is under fire to halt the process. There are many factors relating to the growing world hunger and only one is from corn based ethanol. A 5-year drought in Australia has virtually shutdown rice production that fed 20 million people. Droughts in Africa have reduced crop sizes of several different feed crops. Wheat prices have risen 120% over the last year. Rice, a staple food for nearly 2 billion people is up 75% in just the last two months. The World Bank estimates that on average food prices have risen 83% over the past three years. According to the World Bank president "the U.S. and Europe have been focused on filling their tanks while the rest of the world was trying to fill their stomachs." Fertilizer prices have risen several hundred percent over the last 3 years. We may have reached the carrying capacity of the planet. Corn ethanol may have been doomed from the start but this is just one more reason to give up this folly.

Boone Pickens has changed direction again. He was widely quoted saying oil prices would go down last month. He was shorting oil at the time. He admitted last week that he made a mistake and he had covered his shorts and was long again. His fund fell 21% in Q1 because of his shift from long to short. Pickens said he could see $125 oil and would eventually reach $150 but gave no timeline. He said world production will not exceed 85 mbpd because of high depletion rates on existing fields. We are actually expecting demand to be 88 mbpd in 2008 and 89.6 mbpd in 2009. The difference between Boone's 85 mbpd number and current demand is natural gas liquids (NGLs) and refinery gains. When refiners crack a 42-gallon barrel of oil they end up with something close to 48 gallons due to processing gains. Remember they add stuff to it to make the specific regional blends. In California they end up with 49.59 gallons because they add even more components to cut emissions.

Jim Brown

Sign of the times cartoon

May Crude Futures Chart - Daily

May Natural Gas Futures Chart - Daily

May Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays

None until oil cools

New Non-Energy Plays


Dropped Plays
C Citigroup ** Stopped **

New Watch List Plays Triggered
FLS $113.72 +3.72 Flowserve
UPL $85.01 +2.01 Ultra Petroleum

Portfolio Listing & Top Picks

Top Picks

If you are looking to add another position these 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.


New Plays

Most Recent Plays

FLS $113.72 +3.72 - Flowserve

There was no further weakness and FLS shook off the downgrade and rebounded +8 points from Tuesday's low.

Flowserve was downgraded the prior week by Robert Baird just as it hit a new high at $118. Their price target was $120 and he felt it was fairly valued. At the same time Flowserve was upgraded by S&P and Moody's. Flowserve is expected to earn just over $5 in 2008 and $10 by 2010. Even according to Baird this is not priced into the stock. I think they should be immune to any light market selling with support at $105 but could suffer in any real downdraft.

Company Info:

Flowserve Corporation (Flowserve) is a manufacturer and aftermarket service provider of flow control systems. The Company develops and manufactures precision-engineered flow control equipment, such as pumps, valves and seals, for critical service applications. Flowserve offers a range of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. The Company sells its products and services to more than 10,000 companies, including engineering and construction firms, original equipment manufacturers (OEMs), distributors and end users. The Company operates through three business segments: Flowserve Pump Division (FPD) for engineered pumps, industrial pumps and related services; Flow Control Division (FCD) for engineered and industrial valves, control valves, actuators and controls and related services, and Flow Solutions Division (FSD) for precision mechanical seals and related products and services.

Breakout trigger: $110 Hit 4/16

Position: OCT $120 Call FLS-JD @ $10.40


UPL $85.01 +2.01 - Ultra Petroleum

A new 27 month high on nat gas helped keep the momentum on UPL. I am hoping their earnings will reinforce the metrics below.

This may seem like a strange play given my thoughts that gas prices could go down this summer. The reason UPL has been rising is the new cross country pipeline to their property in Utah. Once completed they will be able to sell their gas for more money with access to the eastern markets. Ultra is on a capex program to spend $755 million in 2008 to boost production by 18-22%. They pln to boost production another 25-30% in 2009 over 2008 levels. 2008 estimates are for 135-140 BCF. They produced 117 BCF in 2007. 2009 estimates are for 170-175 BCF. 2010 estimates are for 200-205 BCF. That would be nearly double their 2007 production.

Company Info:

Ultra Petroleum Corp. (Ultra) is an independent oil and gas company engaged in the development, production, operation, exploration and acquisition of oil and natural gas properties. The Companys operations are primarily in the Green River Basin of southwest Wyoming. The Company continually evaluates other opportunities for the acquisition, exploration and development of oil and natural gas properties. As of December 31, 2007, Ultra owns interests in approximately 121,652 gross (62,756 net) acres in Wyoming covering approximately 230 square miles. The Company owns an interest in approximately 676 gross producing wells in this area and is operator of approximately 50% of the 676 gross wells. The Company owns interests in 252,629 gross acres in Pennsylvania. On October 22, 2007, the Company sold Sino-American Energy Corporation (Sino-American), which owned its Bohai Bay assets in China.

Breakout trigger: $83 Hit 4/14

Position: 2009 $90 LEAP Call OZH-AR @ $9.40


Play Updates

Existing Plays

USO $93.79 +3.79 - United States Oil Fund *** Short ***

This play is based on the potential for selling in the oil futures as Crude Futures expire next Tuesday. In the April expiration cycle in March the price of crude fell -$10 in the 48 hours following expiration.

Company Info:

United States Oil Fund, LP (USOF) is a commodity pool that issues limited partnership interests or units that may be purchased and sold on the American Stock Exchange (the AMEX). The Company invests in futures contracts for light, sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the New York Mercantile Exchange (NYMEX), International Currency Exchange (ICE) Futures or other United States and foreign exchanges (collectively, Oil Futures Contracts). It holds interests in other oil-related investments such as cash-settled options on Oil Futures Contracts, forward oil contracts, and oil-based over-the-counter transactions. As of December 31, 2007, USOF held 4,754 Oil Futures Contracts traded on the NYMEX and 300 Oil Futures Contracts traded on the ICE Futures. The Company operates under full management control of its sole General Partner, Victoria Bay Asset Management, LLC (the General Partner).

Upside trigger: $90.00 Hit 4/15

Position: May $87 PUT UNA-QI @ $2.70


SPWR $89.33 +1.57 - SunPower

That gain above is very misleading. SPWR gained $13 from Tue/Wed but gave it back on Thursday on earnings concerns. There was also a bill introduced to extend key tax credits but only for one year. Friday was a recovery day to make positive for the week.

SPWR earnings were 15 cents compared to 2 cents in the comparison quarter. After items that was 39 cents when analysts were expecting 35 cents. Revenue rose 92%. The problem was a comment by the company that Q2 was going to be similar to Q1. Traders immediately thought sales were slowing. It was later qualified by a Jefferies analyst that it was just a timing problem as big projects were brought online and revenue counted. SPWR raised guidance again to $1.3-$1.375 billion from the $1.2-$1.3 billion forecast in Q1. It also raised its profit per share guidance by 10 cents to $2.10-$2.20. Revenue is expected to rise by 40% in 2009.

Cypress, which owns 56% of SPWR common stock and 90% of the voting stock, received a ruling from the IRS that would allow CY to spin off SPWR before Nov-09.

Breakout trigger: $66 (hit 3/24))

LEAP Call Spread
LLong 2010 $80 LEAP Call LMO-AP @ $20.00
Shrt 2010 $130 LEAP Call LMO-AW @ $8.70


CY 28.08 +1.79 - Cypress Semi *** Stop Loss $21.50 ***

CY rallied to hit $30 on Thursday after posting earnings of 12 cents, which was 2 cents short of analyst expectations. The gains came on analyst upgrades, a favorable IRS ruling about spinning off PWR and comments from CY calling Q1 the bottom in chip sales. The CEO forecasted record consolidated quarterly revenue in Q2 and all of 2008. He said the company planned to increase profit at a far greater rate than sales.

CCypress, which owns 56% of SPWR common stock and 90% of the voting stock, received a ruling from the IRS that would allow CY to spin off SPWR before Nov-09.

Breakout trigger: $21.50 (hit 3/24)

Position 2010 $25 LEAP Call WSY-AE @ $4.90


MDR - $60.35 +4.35 McDermott Intl ** Stop Loss $55 **

McDermott closed at a new 3-month high and is very close to an all time high (63.01). There was no news but I am not complaining. I will take a $4 move every week.

Breakout trigger: $51.00 (hit 3/24)

LEAP Call Spread
Long 2009 $55 LEAP Call OYZ-AK @ $8.28
Shrt 2009 $75 LEAP Call OYZ-AO @ $3.10


TS $54.30 +3.67 - Tenaris *** Stop Loss $49 ***

Tenaris exploded for a $4 gain after a Goldman Sachs analyst made some positive comments about the sector on Wednesday. No news.

Breakdown trigger: $46.00 hit 3/19

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


HP $56.53 +4.91 Helmerich & Payne *** Stop Loss $51 ***

Amazing! HP is going vertical and still 8 days until earnings on May 1st. Calyon Securities initiated coverage with a BUY.

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

EBAY $31.72 +0.84 - Ebay Inc *** Earnings Short ***

EBAY posted higher earnings but failed in almost every other metric. I feel good about this position since despite two monster days this week EBAY only managed an 84-cent gain. Once Google is behind us, and possible Amazon, I think EBAY will start heading down. Fortunately a gap open on Monday got us into the play cheaper.

Entry 4/14 @ 30.87

Position: May $30 PUT XBA-QF @ $1.10


C $25.11 +1.75 - Citigroup *** Stopped $22.50 **

Citi dropped to stop us out when Wachovia stunk up the place on Monday. Citi's earnings were better than expected on Friday but that did us no good. We exited for almost a break even.

Position: 2010 $25 LEAP Call WRV-AE @ $4.00, exit $4.10, 4/14

Position: June $17.50 Put C-RR @ $1.25, exit .68, -.57. 4/14

Covered LEAP Calls

AAPL $161.04 +13.90 Apple Inc *** Covered LEAP Call ***

Apple hit a new 3-month high on Friday as the short covering hit every tech stock. Apple has earnings next Wednesday.

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 $123.22 -7.37 Research in Motion

RIMM benefited from the same short covering in tech stocks as Apple and closed right at a 6-mo high.

If we continue holding the position until January and let it get called away your profit will be $34.80 when the stock is called away for $110.

Alert entry 11/12 @ $102.60

Covered LEAP Call:

LONG RIMM @ $102.60 (cost $102.60 -9.10 $150 LEAP = 93.50)
SHORT 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
Core Labs
MOS Mosiac
COP ConocoPhillips

Current Watch List

PBR - Petrobras

We have had the most horrible luck on this company. As it was declining towards $110 last week some idiot in the NPA in Brazil said they had discovered a 33 billion barrel deposit. Petrobras denied it and the official may be charged with a crime for spreading disinformation. The market still has 33 billion imprinted on their foreheads and we may never see a dip here. I changed the triggers and the strikes to compensate somewhat but I am not going to chase it.

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: $115 *** New Trigger ***

Buy 2010 $120 LEAP Call YMO-AD
Sell 2010 $180 LEAP Call YMO-AX ** New Strike **


USO - U.S. Oil Fund

If we do get a drop in crude from the May futures expiration cycle maybe we can get lucky with these higher strikes.

Breakdown trigger: $87 *** New trigger ***

Buy 2009 $90 LEAP Call OLL-AL *** New Strike ***
Sell 2009 $120 LEAP Call XNF-AP *** New Strike ***


CLB - Core Labs

We have had a tough time with Core. We were stopped out on the March dip and then missed the current rise. If we get a post expiration decline I would be willing to risk another entry at $130.

Company Info:

Core Laboratories N.V. (Core Lab) is a provider of reservoir description, production enhancement and reservoir management services to the oil and gas industry. Core Lab has over 70 offices in more than 50 countries. The Company derives its revenues from services and product sales to clients primarily in the oil and gas industry. Its reservoir optimization services and technologies are interrelated and are organized into three complementary segments: Reservoir Description, which encompasses the characterization of petroleum reservoir rock, fluid and gas samples; Production Enhancement, which includes products and services relating to reservoir well completions, perforations, stimulations and production, and Reservoir Management, which combines and integrates information from reservoir description and production enhancement services.

Breakdown trigger: $130

Buy 2010 $140 LEAP Call LYM-AH
Sell 2010 $175 LEAP Call LYM-AU


MOS - Mosaic

Another run away stock that exploded for $30 on news headlines on Potash (POT). Nothing seems to phase it but I refuse to chase it. Look for a pullback for an entry.

Company Info:

The Mosaic Company (Mosaic) is a producer of phosphate and potash combined, as well as nitrogen and animal feed ingredients. The Company operates its business through four business segments: phosphates, potash, offshore and nitrogen. The Phosphates segment operates mines and concentrates plants in Florida that produce phosphate fertilizer and feed phosphate, and concentrates plants in Louisiana that produce phosphate fertilizer. The Potash segment mines ad processes potash in Canada and the United States and sells potash in North America and internationally. The Offshore segment produces and markets fertilizer products and provides other ancillary services to wholesalers, cooperatives, independent retailers, and farmers in South America and the Asia-Pacific regions. The Nitrogen segment consists of its equity investment in Saskferco and Mosaics nitrogen sales and distribution activities.

Breakdown trigger: $120

Buy 2010 $140 LEAP Call LXW-AX
Sell 2010 $240 LEAP Call KCA-AH



Based on the recent announcements by BP it may be time to take another run at this stock. When Thunderhorse comes online in Q3 it should get a lot of press due to the high volume of oil they expect to produce. Maybe BP's troubles are over.

*** CAUTION - Earnings are April 29th ***

Company Info:

BP p.l.c. (BP) is a holding company. The Company three business segments: Exploration and Production, Refining and Marketing and Gas, Power and Renewables. Exploration and Productions activities include oil and natural gas exploration, development and production (upstream activities), together with related pipeline, transportation and processing activities (midstream activities). The activities of Refining and Marketing include the supply and trading, refining, marketing and transportation of crude oil, petroleum and chemicals products. Gas, Power and Renewables activities included marketing and trading of gas and power, marketing of liquefied natural gas (LNG), natural gas liquids (NGLs) and low-carbon power generation through its Alternative Energy business. During the year ended December 31, 2007, BP acquired Chevrons Netherlands manufacturing company, Texaco Raffiniderij Pernis B.V. In April 2008, BP registered in Russia its subsidiary BP Exploration Services.

Breakdown trigger: $65.

Buy 2010 $70 LEAP Call WAO-AN


COP - ConocoPhillips

Earnings are April 24th. Maybe we can get a double dip of a drop in crude futures and earnings from ConocoPhillips.

Company Info:

ConocoPhillips is an international, integrated energy company. It has six operating segments. Exploration and Production segment explores for, produces and markets crude oil, natural gas and natural gas liquids. Midstream segment gathers, processes and markets natural gas, 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. LUKOIL Investment segment consists of its equity investment in the ordinary shares of OAO 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 Companys normal scope of operations. In October 2007, American Electric Power Company, Inc. sold its 50% interest in the Sweeny Cogeneration plant in Texas to ConocoPhillips.

Breakdown trigger: $80

BUY 2010 $90 LEAP Call YRO-AR


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