Option Investor

Weekly Newsletter, Saturday, 05/17/2008

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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

Do We Dare Try Again\?

Oil hit $127.82 on Friday with expiration of the June contract on Monday. Do we dare try another short on the USO or just plan on buying the dip? I think I would rather ponder the meaning of life than try to pick a side on that trade. Oil refuses to decline and Goldman analysts have made it a personal challenge to see how high they can push prices. Obviously Goldman's trading book is heavily weighted in oil for them to continue to pound the table for higher oil prices. Do we dare go against them?

On Friday Goldman Sachs upped their forecast for the average price of oil in the second half of 2008 to $141 per barrel. That is the expected average price so there has to be higher prices for that to be an average. That suggests $150 and the bottom range of their super spike theory as the potential lower end of the upward range. Is that confusing? What I am trying to say is that Goldman expects highs of at least $150 in order to get a $141 average. Their super spike theory goes to $200 so there is plenty of room on the upside if they are right.

The new forecast sent oil prices to nearly $128 despite two other events that were ignored. Saudi Arabia announced during President Bush's visit that they had increased production by 300,000 bpd to 9.45 million barrels per day. This increase was to offset production declines by other OPEC nations. It was also just a token amount but traders ignored it completely.

The second announcement was the Energy Dept saying they were not going to contract for any SPR deliveries for six months beginning July 1st. That theoretically puts an extra 70,000 bpd back on the market. Since it is only 0.004% of our daily needs there was good reason for traders not to get excited. As I have said before the SPR deal is just pabulum for the masses and a way for lawmakers to show they really care about high gasoline prices. Don't make get me started on that rant.

It cost more to take that holiday trip next week with national gasoline prices hitting $3.787 on Friday and diesel reaching a record of $4.482 per gallon. Since prices are normally the highest around Memorial Day I think there is a very good chance we will see $4 gasoline. Now be honest. When we were discussing $4 gasoline a couple months ago at $3.25 did you really think it would happen? Better yet, did you think it would happen before the arrival of peak oil? I doubt it even the confirmed peak oil followers expected it this year.

OPEC claims there is plenty of oil in the system and yet there is not enough to go around. Why is that so? I have explained this many times in the past but not for several months. All oil is not equal. There is light sweet crude with very little sulfur that is easily refined into gasoline. There is heavy sour crude that flows slowly and has very high sulfur levels. Only a few refineries can refine this grade into gasoline because of the extra and expensive processes necessary to remove the sulfur before it becomes gasoline or diesel. There is also a variety of grades in between. A single refinery is built to process a specific kind of oil. If it is setup to refine light sweet crude then it cannot refiner heavy sour because the processes are different. That is a simple explanation but there are dozens of variants. Suffice to say that a refinery can only process certain grades of crude and no others. This is the equivalent of you pulling into a filling station for regular unleaded and all they have is diesel. You can't use it even if it was selling for 10 cents per gallon. If you don't have gasoline you can't drive. Period.

There is plenty of oil available in the world. Unfortunately there is a shortage of light sweet crude. For instance Iran is drowning in sour crude at present for what was initially thought to be a refinery down for maintenance reasons. There are tankers with more than 28 million barrels of Iranian crude parked in the Persian Gulf waiting for that refinery to restart. It turns out that may not be the problem but I will get to that later. Iran pumps 4 mbpd and exports 80% of that oil. It is heavy sour crude with few refineries capable of using it. That parked oil has increased from 20 million barrels to 28 million in just the past week. Plenty of oil but no place to go. Some analysts wonder if this excess oil is the result of U.N. sanctions finally taking hold. We found out on Friday that Iran had just contracted for another VLCC from Singapore's Tanker Pacific. Nobody really knows why this oil is just parked in the gulf and costing Iran $56,000 per day per ship to just sit there. (I will pose another scenario later.)

Venezuela's oil is also a heavy crude with very few refineries built to process it. If the U.S. suddenly cut off imports from Venezuela they would be swimming in oil very quickly with nobody to buy it.

When OPEC says there is plenty of oil in the system and they can't find buyers for all of their supplies they are actually telling the truth. They are just not telling the whole truth. There is a surplus of sour crude and a shortage of sweet crude. When you see us talk about the price of oil that is the price of sweet crude, which is the benchmark for oil prices. Everything else is priced at a discount to light sweet crude. OPEC has complained for years that there is not enough refining capacity around the world to take advantage of all the crude available. They are completely correct. If there were a dozen more refineries capable of processing sour crude then there would be no oil shortage today. In a couple years definitely but not today.

So how do we capitalize on this fact. Normally I would say buy Valero because they have the largest sour crude refinery capacity in the states but with oil prices so high even they are having trouble making money.

Short of trading oil futures the next best thing is to buy the USO on dips and continue to invest in the deepwater drilling sector and service companies. The majority of oil found in the Gulf is sweet crude however some of the deeper discoveries have been heavy crude. Regardless of the type of oil found the only politically free zone left to explore is the oceans. Countries are going to be forced to rely on the drillers to explore offshore because the countries of the world simply do not have the technology to do it themselves. Mexico just spent $150 million to drill a dry hole in 3,000 ft of water and that is the extent of their technology. Over 3,000 ft and they are out of their league. Petrobras is launching a monster spending spree to enable them to drill hundreds of wells to 26000-30000 feet in 7000 feet of water over their new discoveries. The beneficiaries are going to be RIG, NE, DO, SeaDrill and others in the sector regardless of whether they get a Petrobras contract or not. Whatever equipment Petrobras ties up for the next ten years of drilling will not be available for other projects. It will cause a tremendous ripple down effect in the sector.

When do we invest more? Historically gasoline prices decline after Memorial Day. Nobody knows if that cycle will appear this year or not but there should be some traders trying to speculate on that trend. If gasoline falls so will crude. It may only be temporary but this suggests we should be ready to buy the dip when and if it comes.

Following the dip in May the price of crude typically rises into hurricane season, which begins on June 1st. I know you are probably saying what dip? Picking direction in today's volatile market is a crapshoot. Personally I think we should try to short the USO one more time at Monday's close. Then we need to target a dip to get long again for the summer in both the USO and some more energy stocks. If you do not want to take the risk in the short then don't do it. You are in control. I lay out the potential plays and you decide which to bet on.

I regret to inform you that Fluor (FLR) did not trigger our watch list entry before spiking +$30 on their blowout earnings report. Actually if I had put a breakout trigger on FLR it would have been ugly. We would have been filled at the absolute high on a $30 gap open. From my perspective here missed money is better than lost money. We did get a good entry on FWLT off the Fluor news so all was not lost.

Iran musings: Iran now has 28 million barrels of crude parked in the Persian Gulf. Why? Here is where the plot thickens. You may remember Iran threatened to cut production last week and that sent oil prices soaring before the claim was softened. Is Iran just waiting for oil prices to go higher to get a better price for their oil? Was the production cut rumor a way to jack up prices even higher? Surely they would not take this big of a gamble worth billions of dollars with a plan to bluff prices higher. Absolutely they would! They tried this exact strategy in 2006 and failed. Beginning in March of 2006 Iran started making threats that they were going to cut production while storing 20 million barrels of crude in tankers parked in the gulf. Unfortunately for Iran instead of paying Iran's higher price for crude there was enough oil on the market then for traders to just buy elsewhere. Iran's bluff did not work and they ended up selling it at a huge discount to Shell and India's Reliance. It appears Mahmoud Ahmadinejad is so desperate for money to keep his regime alive that he is trying the same trick and with Saudi willing to pump more of a higher quality oil it appears Iran is going to lose money again. Iran is in economic trouble with 45% of the population kept inline only by heavy subsidies and military force. The other 55% are ethnic Persians. Iran is extremely vulnerable right now. If the U.S. was able to pressure Iran's primary oil buyers (Japan, China, South Korea and Italy) to look elsewhere for another month or so then Iran would really be in trouble and the regime could fail. 80% of Iran's revenues come from oil and for whatever reason it is not selling. Now might be the time to tighten the noose.

Jim Brown

Sign of the times cartoon

June Crude Futures Chart - Daily

June Natural Gas Futures Chart - Daily

June Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays
USO $102.41 Short

New Non-Energy Plays


Dropped Plays
EBAY Ebay short Expired

New Watch List Plays Triggered
$79.60 +8.60 Foster Wheeler
PH $85   Parker Hannifin
CRR $49.02 1.02 Carbo Ceramics

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.

I like all of these this week. Try to buy them on a dip!


New Plays

Most Recent Plays

USO $102.41 - Short

You know the drill. Futures expire on Monday. Odds of a decline are still great. Iran has 30 million barrels of crude being held off the market. If they capitulate that much extra oil could push prices lower even though it is low quality high sulfur crude.

This trade has risk! A lot of risk but we should be able to manage that risk by making our entry at the close on Monday. Shorts will have covered and the July contract will become the new front month contract.

Buy at the close on May 19th or a spike to $104.

Buy July $100 Put IYS-SV with a stop loss at $105.50

Target $95 for an exit

New Watch List Plays Triggered

FWLT $79.60 +8.60 Foster Wheeler

Definitely no complaints here. FWLT rocketed higher on the Fluor news and never looked back.

Company Info:

Foster Wheeler Limited operates through two business groups, the Global Engineering & Construction Group (Global E&C Group) and the Global Power Group. The Global E&C Group, which operates globally, designs, engineers and constructs onshore and offshore upstream oil and gas processing facilities, natural gas liquefaction facilities and receiving terminals, gas-to-liquids facilities, oil refining, chemical and petrochemical, pharmaceutical and biotechnology facilities and related infrastructure, including power generation and distribution facilities, and gasification facilities. The Global Power Group designs, manufactures and erects steam generating and auxiliary equipment for electric power generating stations and industrial facilities globally. In February 2008, the Company completed the acquisition of Biokinetics. On April 7, 2006, the Company completed the purchase of the remaining 51% interest in MF Power.

Breakout trigger: $71 Hit 5/13

Position: 2010 $80 LEAP Call LWM-AP @ $16.80


PH $85 - Parker Hannifin

Just as PH broke out last week over our $85 trigger they announced the sale of $775 million in debt. Talk about great timing. PH decline back to our entry point and then held its ground on no other news.

Company Info:

Parker-Hannifin Corporation is a full-line diversified manufacturer of motion control products, including fluid power systems, electromechanical controls and related components. In addition to motion control products, the Company also is a producer of fluid purification, fluid and fuel control, process instrumentation, air conditioning, refrigeration, electromagnetic shielding and thermal management products and systems. Its manufacturing, service, distribution and administrative facilities are located in 35 states and in 42 foreign countries. Its motion control technology is used in the products of its three principal business segments: Industrial, Aerospace, and Climate & Industrial Controls. The products are sold as original and replacement equipment through product and distribution centers worldwide. Parker products are supplied to over 427,000 customers in manufacturing, transportation and processing industry. In April 2008, the Company acquired Vansco Electronics and Ventrex Inc.

Breakout trigger: $85 Hit 5/13

Position: 2010 $90 LEAP Call LWU-AR @ $13.50


CRR $49.02 1.02 - Carbo Ceramics

Carbo has some resistance at $50 but with the oil patch looking for ways to pump more oil it should eventually break.

Company Info:

CARBO Ceramics Inc. is a producer and supplier of ceramic proppant and a provider of fracture and reservoir diagnostic services and fracture simulation software through its subsidiary, Pinnacle Technologies, Inc. (Pinnacle). The Company conducts its business within two operating segments: Proppant and Fracture and Reservoir Diagnostics. The Proppant segment consists of manufacturing and selling ceramic proppant for use primarily in the hydraulic fracturing of oil and natural gas wells. Through its Fracture and Reservoir Diagnostics segment, the Company provides fracture mapping and reservoir diagnostic services, sells fracture simulation software and provides engineering services to oil and gas companies worldwide. Sales outside the United States accounted for 34% of the Companys sales during the year ended December 31, 2007. The Companys largest customers for ceramic proppant are BJ Services Company, Halliburton Energy Services, Inc. and Schlumberger Limited.

Breakout trigger: $48 Hit 5/12

Position: Dec $50 Call CRR-LJ @ $5.80


Play Updates

Existing Plays

JEC $96.45 +9.69 Jacobs Engineering

Another Fluor winner. No other news besides the FLR earnings.

Breakout trigger: $90 Hit May 5th

Position: 2010 $100 LEAP Call WEU-AT @ $16


PBR $70.65 +6.05 Petrobras

Petrobras reported a 68% rise in Q1 profits on Monday that totaled $4.1 billion. Profits were 37% above the prior quarter. Petrobras is a company that is doing everything right. Profits would have been a lot higher were it not for price controls on fuel inside Brazil. As those controls are raised so will Petrobras profit move higher.

Bloomberg announced last week that Petrobras had contracts to lease 80% of the world's deepest sea drilling rigs. Petrobras is contracting drillships that can drill in 10,000 feet of water. According to Rigzone there are only 21 such vessels. Petrobras as already signed 5-year contracts on six rigs at rates of $410,000 to $580,000 per day. Petrobras is also negotiating for as many as 17 more with most of those being new construction. Daily drilling rates are running $600,000 per day for those ships. Petrobras now controls seven times more capacity for drilling over 7500 feet of water than the next largest holder. Analysts expect other oil companies to be forced to pay as much as $50,000 per day more than Petrobras rates to contract any remaining rigs.

** See portfolio listing for any stop loss **

Breakout trigger: $125.50 hit 4/28

Position: 2010 $150 LEAP Call YMO-AV @ $22.10


NE $65.44 +2.82 - Noble Corp

No news but Friday's close was a new historic high!

Noble recently won a $4 billion contract to drill for Petrobras off the coast of Brazil. This is a monster payday and just one area of exploration for Noble.

** See portfolio listing for any stop loss **

Breakdown trigger $56.00 hit 4/29

Position: 2010 $70 LEAP Call YVJ-AN @ $8.10


RIG $160.54 +6.88 - Transocean

Nice recovery after the $15 dip the prior week. RIG is back at new high resistance at $160 after multiple upgrades last week.

RIG is the premier deep-water driller and there is no scenario where they don't continue to move higher.

** See portfolio listing for any stop loss **

Breakdown trigger: $150 Hit 4/29

Long 2010 $170 LEAP Call YDR-AN @ $24.00
Shrt 2010 $230 LEAP Call YDR-AW @ $8.50


NOV $79.00 +1.59 - National Oilwell Varco

A new 7-month high on Friday on no news. It is great to be an oil service company today.

** See portfolio listing for any stop loss **

Breakdown trigger: $67 Hit 4/30

Position: NOV $80 Call NOV-KP @ $5.40


FLS $128.92 +7.56 - Flowserve

A new historic high at Friday's close on no news. Love that momentum!

** See portfolio listing for any stop loss **

Breakout trigger: $110 Hit 4/16

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

Non-Energy Positions

MOS $129.66 +3.24 Mosaic

The passage of a new farm bill with enough votes to be veto proof helped send the fertilizer stocks higher. MOS is knocking on resistance at $130 and next week could be the breakout week.

** See portfolio listing for any stop loss **

Breakdown trigger: $120 Hit 4/29

Long: 2010 $140 LEAP Call LXW-AX @ $35.10
Short: 2010 $240 LEAP Call KCA-AH @ $13.90


EBAY $31.24 - Ebay Inc *** Expired ***

We lost our buck on this play. EBAY declined to $30 after earnings but just would not move any lower.

Entry 4/14 @ 30.87

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

Covered LEAP Calls

AAPL $187.82 +4.17 Apple Inc *** Covered LEAP Call ***

Could it be that Apple is about to top? $190 is beginning to look like resistance.

No change. Over $150 we are at max profits.

Long: AAPL @ open of $177.52 (Jan-14th open)
Short: 2009 $150 LEAP Call VAA-AW (APV-AJ) @ $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 $140.36 +7.59 Research in Motion

Two new BlackBerry announcements within a week of each other? Definitely an embarrassment of riches.

No change. We are at max profits over $110.

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
FLR Fluor

New Watch List Entries
Pride International
VLO Valero

Current Watch List


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.

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: $68. *** I am holding this level ***

Buy 2010 $70 LEAP Call WAO-AN


COP - ConocoPhillips

COP is still running and I am not going to chase them. I am going to raise the trigger slightly but just to support.

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: $84 *** No change ***

BUY 2010 $90 LEAP Call YRO-AR


PDE - Pride International

Pride is being rumored as a takeover target as one of the few remaining ocean drillers still independent. With a market cap of only $7.7 billion they would be only a snack for one of the bigger firms interested in expanding some more.

Company Info:

Headquartered in Houston, Texas, Pride International, Inc. is one of the world's largest drilling contractors. Pride provides contract drilling and related services to oil and gas companies worldwide.
With over 7,000 employees, Pride offers a multinational workforce with offices in the United States, Africa, Asia, Europe and South America.
We have positioned our fleet in some of the world's largest and most active exploration and production areas, with a market presence in West Africa (Angola), Latin America (Brazil), the Gulf of Mexico, the Mediterranean and Middle East. Today, we operate a total of 64 rigs.

Breakdown trigger: $44

Buy Jan 2009 $50 Call PDE-AJ

I went with a Jan call instead of a LEAP because an acquisition would limit LEAP appreciation. I wanted to be close to the current price with a cheap option.


VLO - Valero

Is it time to venture back into the refiners? While I am not convinced VLO has bounced off $45 twice in he last two months. Eventually the crack spread has to widen or gasoline prices will go higher from too little supply. Refiners are not going to refine it at a loss. Valero has a large percentage of their capacity in sour crude capability. They should be able to undercut anybody that depends on sweet crude. I am willing to take a flyer here if resistance at $50 can be broken.

Company Info:

Valero Energy Corporation is a Fortune 500 company based in San Antonio, Texas, and incorporated in Delaware. Valero's common stock is listed for trading on the New York Stock Exchange under the symbol "VLO." The company has approximately 22,000 employees and assets valued at $38 billion.

The largest refiner in North America, Valero has an extensive refining system with a throughput capacity of approximately 3.1 million barrels per day. The company's geographically diverse refining network stretches from Canada to the U.S. Gulf Coast and West Coast to the Caribbean.

Valero has a mid-stream logistics system that supports Valero's refining and marketing operations.

A marketing leader, Valero has approximately 5,800 retail and wholesale stores in the United States, Canada and the Caribbean under various brand names including Valero, Diamond Shamrock, Shamrock, Ultramar, and Beacon. The company markets on a retail and wholesale basis through a bulk and rack marketing network in 44 U.S. states, Canada, Latin America and the Caribbean.

Breakout trigger: $51
Buy 2010 $60 LEAP YPY-AL
Breakdown trigger: $45
Buy 2010 $50 LEAP YPY-AJ


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