Option Investor

Weekly Newsletter, Saturday, 05/24/2008

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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

One Heck of A Week

June futures closed just over $126 last Friday with expiration of the QM electronic contract on Monday and the CL open outcry contract on Tuesday. The perfect play setup appeared to be short the expiration and ride down the post expiration wave. In hindsight we know that was not a winning plan.

We found out this week in the commitment of traders report that short interest by small investors and speculators in the July crude contracts was at record levels dating back to 1986. Everyone with a futures account thought the play was to short crude at the double event of $130 and expiration. Everyone was rewarded with a monster spike and short squeeze for their troubles. When everyone thinks they "know" the right play and it is the same play it rarely works.

We all know what happened last week only nobody knows why other than blame it on the short squeeze. Crude spiked to a record $135.04 on Wednesday's inventory shortfall. Oil inventories fell by -5.3 million barrels when analysts were expecting only a 900,000 barrel decline. The difference came from a second consecutive week of declines in the daily imports of crude by 700,000 barrels per day. That is a drop of 1.4 mbpd in just the last two weeks. I believe, as in the past, that this is just a timing issue given the 30-45 day transit time from Middle East ports. Eventually we will have a week where all the tankers show up at once and the numbers will correct. However two things are working against us. Refinery utilization has risen +3% over the last two weeks and we are entering the heavy driving season starting this weekend where gasoline demand spikes sharply. This could cause several weeks to pass before inventory levels normalize.

Inventory Table

However, the Dept of Transportation said miles driven in March fell by 11.2 billion over March 2007 due to the high cost of gasoline. That was the largest year over year drop since 1942. Only the oil shocks of the 1970s came close to depressing driving that severely. The -4.3% drop in miles was the first decline in the month of March since 1979. The price of SUVs fell 17.14% from March of 2007 while small economical cars rose +2%. GM and Ford both said they were going to move away from large SUVs and trucks and downsize their lines to smaller more fuel efficient vehicles. That would have been a death knell 4-5 years ago. America's love affair with the automobile has fueled the automakers desire to make bigger and more powerful cars year after year. The Hummer, Expedition and Navigator are examples of major gas guzzler SUVs. All are in for a makeover to smaller versions. The car companies made a lot of money building $60-$75,000 surburban type vehicles. They are going to have to cut that profit to the bone to compete with the $20,000 hybrid from Toyota. Ford said it no longer expected to return to profitability this year and also said there had been a real shift in customer buying habits in just the last three weeks as gasoline moved over $3.75 per gallon.

America's Research Group said customer buying habits were changing dramatically. They found the number of consumers using shopping lists to avoid impulse buying had risen sharply. Consumers were trying to budget $75 fill ups with many commuters filling up twice a week. That is a major expense for already tight budgets. ARG said when gasoline hits $4 per gallon the community screeches to a halt. We have seen $4 gasoline in 17 states and the impact has been the same in all regions. When that $4 level is reached there is an almost immediate halt to unneeded driving.

I am in Dallas this weekend. I left Denver Wednesday in a 2008 suburban with family and several hundred pounds of gear. The roads were almost completely deserted. Other than Oklahoma City and within 50 miles of Dallas there was almost zero traffic. My mother lives on a hill overlooking a major highway in north Texas. The road noise used to be so bad you could not hear a person speaking outside. This week the cars and trucks are so scarce they are almost unnoticed. This is a holiday week but you could not tell it from the traffic.

My wife was broadsided two weeks ago so we took her car insurance rental on the trip. It came from Enterprise Car rental and was a flexfuel car. That is one that burns either gasoline or E85 Ethanol. I have driven about 30,000 miles on road trips over the last two years and have never seen an E85 pump. I am sure they exist somewhere but not on the roads I traveled. I was still impressed with the car and the 18-19 mpg on unleaded gas. I know it does not compete with compact car economy but with extra people and gear it did the trick. If GM can continue this trend to higher mileage vehicles they could attract a new crop of buyers now that economy is all the rage. At $4 gasoline my road trip days are about over. We planned them over the last two years to get them done before the price of gas made them prohibitive. I think that time has come.

$135 oil sure got the media's attention. The $20 rise in just the last two weeks was an event they could not overlook regardless of how introverted they are to local news. The flurry of new price predictions scared many into running oil specials with titles like America's Oil Crisis. The lawmakers got into the act with their inquisition of the CEOs from the top oil firms. When the cameras were turned on it was not the oil companies speaking but a tirade of complaints from every lawmaker while the CEOs sat trying to look attentive. When they were finally allowed to answer a question they were almost unanimous in their fundamental reason for higher prices. That reason was supply and demand. Not enough supply and too much demand.

Drilling in ANWR and off the continental shelf was discussed repeatedly but they are not the answer. If ANWR was opened along with the shelf they would produce at most 2 mbpd total. That is only 10% of our daily consumption and would only impact the price at the pump by less than a dime in the first year with a decrease to a nickel a year later.

The oil story has picked up speed quickly and the timeline is accelerating. I am going to produce a new update to the oil crisis story with some real world "what should we do" content and answers to the hundreds of emails I have received lately. I think I finally have everybody's attention. That update will be out in July. There will be a Peak Oil seminar in October on the West Coast. I will be posting additional info here in a couple weeks. Seating is going to be limited so watch for the announcement if you are interested in attending.

Jim Brown

July Crude Futures Chart - Daily

June Natural Gas Futures Chart - Daily

June Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays
PDE Pride International

New Non-Energy Plays

Dropped Plays
USO   Short *** Stopped ***
PH   Parker Hannifin *** Stopped ***
MOS $119.80  -9.80 Mosaic *** Stopped ***

New Watch List Plays Triggered


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

PDE - Pride International

Pride was on the watch list at $44 and missed being triggered on Friday by 6 cents. I am going to take the entry at Friday's close of $44.93. Zacks reiterated a buy rating on PDE on Friday based on their $9.4 billion backlog and their emergence as a pure play deepwater driller. They have sold off their non-core assets to leverage the deepwater play. The market is still valuing them as a shallow water jackup play and they are no longer in that sector. They are a strong takeover target given their small size and sector.

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.

Buy Jan 2009 $50 Call PDE-AJ currently $3.70

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.


Play Updates

Existing Plays

USO $106.95 - Short *** Stopped ***

It was a quick play. It was triggered at the close on the 19th at $5.50 and closed when it hit the stop loss the next morning at $105.50. The option price when the stop was hit was $4.40 for a loss of $1.10.

July $100 Put IYS-SV @ $5.50, exit $4.40, -1.10


FWLT $74.30 -5.30 Foster Wheeler

Profit taking on an ugly market. There was no news other than increased buying by Boone Pickens.

Breakout trigger: $71 Hit 5/13

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


PH $80.57 -4.43 - Parker Hannifin *** Stopped ***

PH declined on no additional news other than the bad market and their announcement of a debt sale the prior week. We were unlucky entering it just before the debt announcement and that turned the tables against us.

Breakout trigger: $85 Hit 5/13

Position: 2010 $90 LEAP Call LWU-AR @ $13.50, exit $10.50


CRR $48.00 -1.02 - Carbo Ceramics

Carbo had no news and the same chart pattern as the broader market. After gaining $1.02 the prior week it gave exactly the same amount back.

Breakout trigger: $48 Hit 5/12

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


JEC $91.65 -4.80 Jacobs Engineering

JEC gave back half of last week's gains on no news. Boone Pickens disclosed he had 904,000 shares.

Breakout trigger: $90 Hit May 5th

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


PBR $72.38 +1.73 Petrobras

Petrobras reported a new sub-salt find of light oil in the Santos Basin. It is still unclear if this is part of the larger Sugar Loaf/Carioca field in a single oil bearing structure or another deposit. Either way Petrobras can do no wrong in the exploration dept.

Bloomberg announced the prior 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 $62.87 -2.57 - Noble Corp

Noble declined $5 from the early week high on no news other than a half dozen puff pieces on why Noble is such a screaming buy right now.

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 $152.01 -8.53 - Transocean

That was really painful but we are still well above our stop at $145. Assuming the market finds some traction RIG should do fine. They are the biggest deepwater driller in a sector where day rates are literally going up daily.

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 $81.35 +2.35 - National Oilwell Varco

Nice gain for a bad week. Baker Hughes agreed to pay a unit of NOV $100 million to settle a patent suit on drill bits.

** See portfolio listing for any stop loss **

Breakdown trigger: $67 Hit 4/30

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


FLS $130.11 +1.29 - Flowserve

Flowserve announced on Friday it had been selected to supply valves for two nuclear power plants in China that are being built by Westinghouse Electric. This caused a $5.60 gain for FLS on Friday.

** 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 $119.86 -9.80 Mosaic *** Stopped ***

Nothing but positive news but momentum stocks suffer the most in a weak market. MOS declined to our stop at $120 on Wednesday taking us out of the play.

** See portfolio listing for any stop loss **

Breakdown trigger: $120 Hit 4/29

Long: 2010 $140 LEAP Call LXW-AX @ $35.10, exit 29.78
Short: 2010 $240 LEAP Call KCA-AH @ $13.90, exit 11.50

Covered LEAP Calls

AAPL $181.17 -6.45 Apple Inc *** Covered LEAP Call ***

Not a fun week for Apple but no negative news. However, Import Spy reported Apple took delivery of 188 ocean containers each labeled as holding 44,000 units of "electric computers" and a designation Apple has not used before. Import Spy claims there has been no change in any of the order patterns for any of its existing computer products. Spy believes these were the new 3G iPhones they could announce any day.

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 $131.64 -8.72 Research in Motion

No specific news on RIMM but an Apple 3G iPhone announcement with immediate delivery could be ugly for RIMM on announcement day.

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

New Watch List Entries


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


VLO - Valero

We came really close on VLO last week but fortunately the stock eased just before hitting our breakout trigger. I would much rather buy the dip than a breakout.

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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