Option Investor

Weekly Newsletter, Saturday, 10/25/2008

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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

Who Are They Kidding?

OPEC met, announced a 1.5 million barrel and was promptly laughed out of Vienna. Despite making a point to say that everyone had agreed to honor their new quotas I don't think anyone believed them. The price of oil declined to $62.50 intraday and close off -3.69 at $64.60. I has not been a good quarter for crude.

With the prospect for continued OPEC cheating we could see a test of $60 soon. However, several analysts were calling Friday's low as a market bottom in crude. Since we have a bottom call almost every week I am not applying too much credibility today. The bearishness in crude options is at historic levels. There are 128,000 futures put contracts and only 4,000 call contracts in force on crude. When this reverses it could be dramatic.

The new OPEC quotas don't match up with current production. Angola would have to pump more to get their new reduced quota. I put these tables in the OptionInvestor market wrap this weekend but I am going to reprint them here for those who did not see the wrap.

The first table shows the old and new quotas for the 11 OPEC members who have quotas. The second table shows the amount each would have to cut from actual production to meet the new quotas. Notice the amounts are significantly different.

OPEC Quota Change Table
[Image 1]
OPEC Quota Change from Actual Production
[Image 2]

The odds of OPEC members actually cutting production by 1.822 mbpd or even 1.5 mbpd are extremely slim. Some analysts doubt they will even hit 1.0 mbpd in reduced production. The answer to the oil price question is clear. As long as they continue to over produce and demand continues to decline in a global recession the price of oil will decline.

The biggest plus to this decline is the drop in the cost of gasoline. Currently the U.S. average is $2.78 but in some states it is already under $2.25 with New Jersey at $2.15. Some analysts believe we could see gasoline under $2 soon.

$2 gasoline would be like $5 crack to a drug addict. Demand will return so fast it will be unbelievable. The high price of oil along with the financial crisis created the global recession and ultra cheap oil would help end it. High school drivers would start cruising again. SUVs would begin to sell like hotcakes again. Gas guzzlers would be pulled out of garages to replace the cramped compact cars for family excursions. It is a simple formula. Cheap gasoline equals greater mobility and higher demand. It won't be immediate but it will return. Cheap gasoline will also delay efforts to build economical cars and come up with new technology for transportation. It will change minds of a large number of people who had already planned on buying a hybrid as their next car. Why pay $10,000 more when gasoline is $2 a gallon.

I received several emails again this week suggesting that peak oil was dead. I can assure you nothing is further from the truth. This type of demand destruction cycle will delay it slightly but these cycles have been predicted as we near peak oil. Low prices increases demand, high prices reduce it.

The problem with low oil prices is lack of investment into new exploration. When oil was over $100 investors were rushing to pour money into exploration, development and infrastructure. With prices around $60 the risk reward ratio is not nearly as high and investors can find less risky places to put their cash. Cheap oil means new production will slow several years from now as the lag in exploration appears years later as a lag in production. When prices rise again we will see investment resume but there is always a 5-7 year lag time from exploration to production. It is a vicious circle of intertwined cycles and the result will always be the same.

The market is making me crazier than the decline in oil prices. We were stopped out of five more plays as the forced fund liquidation continued and we saw 500 point swings almost daily. I don't know how you successfully invest in this environment. Stops are impossible but the prospect of a position without stops is even worse. I refrained from adding any new watch list positions again this week. I hesitate to short anything because we are so oversold but I also hate to add to our longs with a global meltdown in progress. I hope everyone got the email in time to act on the Russell 2000 Call play on Thursday. If not the decline on Friday gave you another chance to enter for that $4 option price.

I had a couple readers email asking about other Ultra Long/Short ETFs. Basically they attempt to double the movement of the underlying index. Here are the most common ETFs. Some are optionable, some are not.

Proshares Ultra Long ETFs
[Image 3]
Proshares Ultra Short ETFs
[Image 4]

The current market crisis is being called a 100-year event. To me that sounds like an unparalleled buying opportunity but we have caught too many falling knives over the last few weeks. I think it best if we watch carefully until we get closer to November. October 31st is the fund year-end for 75% of investors. Hopefully this forced selling will be over by Nov-1st and we can rebuild a portfolio with positions that last more than a week.

Jim Brown

December Crude Futures Chart - Weekly
[Image 5]
November Natural Gas Futures Chart - Daily
[Image 6]
November Gasoline Chart - Weekly
[Image 7]

Changes in Portfolio

New Energy Plays

None - see watch list

New Non-Energy Plays
UWM $19.97 Russel 2000 Proshares Ultra ETF

Dropped Plays
FLR Fluor *** Stopped ***
FLS Flowserve *** Stopped ***
MDR McDermott *** Stopped ***
MOS Mosaic *** Stopped ***
FWLT Foster Wheeler *** 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.

We could still see oil prices drop further so I am still being cautious with these picks.


New Plays

Most Recent Plays

UWM $19.97 - Russell 2000 Proshares Ultra ETF

I sent an email out on Thursday suggesting we go long call options on this ETF.


The equity markets appear to be headed for a retest of the recent lows and I believe this will result in an eventual rebound. When the rebound comes even if it is still weeks away I think it could be strong given how severely we are oversold.

I think now would be a good time to try some bottom fishing on a market index. The one I am using is the Russell 2000. I am going to recommend the ProShares Ultra ETF, Ticker UWM. This is the double performance ETF that will respond with twice the speed of the underlying index.

This ETF does not have LEAPS so I am going to recommend the April $25 Call option symbol ULX-DY currently $4.00. The UWM was at $25 at Wednesday's open and collapsed to $20 with today's market drop. If the Russell returns to the 700 level by April and that is where it was just four weeks ago, then the UWM would climb to $50 and the option be worth $25. I think the risk/reward ratio of trying to pick a bottom here justifies the trade.

ETF Info:
Ultra Russell2000 ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the Russell 2000 Index.
Recommended 10/23 at $19.94 on the UWM
Position UWM $25 April Call Option ULX-DY @ $4.00


Play Updates

Existing Plays

Energy Play Updates

FWLT $21.87 -$5.56 - Foster Wheeler *** Stopped ***

After rebounding to $31 on Monday FWLT collapsed with the market to trade under $20. That is more than a 50% drop in only three days. How do you fight market forces like that?

Earnings schedule: Nov 5th

Breakout trigger: $31, hit 10/13

Position: 2010 $40 LEAP Call LWM-AH @ $8.00, exit $4.40 10/23


NE $25.90 -2.47 - Noble

Noble lost -$9 on market weakness but remained above our stop at $20. Earnings on Wednesday rose +20% on "unprecedented" fleet backlogs. They did say there had been a slowdown in engineering and consulting revenue but the outlook remained positive for 2008 and 2009.

Earnings Oct 22nd, $1.43 per share up from $1.18 and est of $1.33

Breakdown Trigger: $35, hit 10.6

Position: 2010 $40 LEAP Call YVJ-AJ @ $5.20


MDR $12.64 -$5.24 - McDermott *** Stopped ***

Friday's gap down open triggered the stop at $12 but the drop in oil prices would have eventually taken us out.

Earnings schedule: November 15th ??

Breakdown trigger: $18, hit 10/6

Position: 2010 $25 LEAP Call YAE-AE @ $3.90, exit $2.00, 10/24


FLR $33.36 -$6.58 - Fluor *** Stopped ***

Gap down on Friday took us out of FLR at our stop of $30. A $6 gap on a $30 stock is 20%.

Earnings Nov 6th

Breakdown trigger: $37.50, hit 10/10

Position: 2010 $50 LEAP Call LLF-AX @ $10.70, exit $5.46 10/24


NOV $25.50 -0.08 - National Oilwell

I am very happy with NOV and a breakeven week! Backlogs rose another billion dollars over the quarter.

Earnings: Oct-23rd $1.44, +28% compared to analyst est of $1.31

Breakdown trigger: $28.50, hit 10/8

Position: May 2009 $40 Call NOV-EH @ $6.00


PBR $21.05 -$5.16 - Petrobras

No specific news but NOV said Petrobras was flush with cash.

No earnings schedule.

Breakdown trigger: $28.50, hit 10/6

Position: 2010 $40 LEAP Call YMO-AH @ $7.00


PDE $14.37 -$3.01 - Pride

Still bumping along on support and no news. Earnings next Thursday.

Earnings Schedule: Oct 30th

Breakdown trigger: $20, hit 10/6

Position: 2010 $25 LEAP Call YAD-AE @ $5.00


FLS $44.63 - $21.18 - Flowserve *** Stopped ***

A $28 drop on a $65 stock on a pure liquidation move. The entire sector was crushed.

Earnings schedule: Oct 28th

Breakdown trigger: $55, 10/08

Buy April $70 Call FLS-DN, $8.50, exit $6.10, 10/23


RIG $66.26 -$4 - Transocean

Support at 63 is holding but only barely. No news and earnings still a week away.

Earnings schedule: Nov-5th

Breakdown trigger: $80, hit 10/6

Position: 2010 $100 LEAP Call YDR-AZ @ 13.40

Non-Energy Positions

ATI $21.29 -$3.03 - Allegheny Technologies

Earnings on Thursday knocked $3 off the price despite beating the street by +7 cents. ATI lowered its forecast for the rest of 2008. Buyers jumped on the Friday morning dip despite the forecast change.

Earnings scheduled for 10/22

Breakout trigger: $26, hit 10/13

Position: 2010 $40 LEAP Call YFQ-AW @ $3.60


MOS $27.78 -$5.88 - Mosaic *** Stopped ***

A $16 drop on a $39 stock. Same sell cycle as the rest of the stops this week.

Entered: Oct 13th @ $36.40

Position: 2010 $50 LEAP Call LXW-AJ @ $12.80, exit $6.72, 10/23


BAC $21.07 -$2.17 - Bank of America

$4 drop in the last three days but still holding above support. Given the beating bank stocks took around the world last week I am happy with BAC performance.

Earnings: Oct 6th @ 15 cents

Entered: Oct 13th @ $20.87

Position: 2010 $25 LEAP Call WBA-AE @ $5.90


GS $ 100.40 -13.90 - Goldman Sachs

Same story different stock. Goldman survived a $25 drop from Monday's high to close at $100. They announced on Friday they were cutting 10% of their workforce. The Fed still loves them se we need to keep the faith.

Earnings were Sept 16th

Breakdown Trigger: $100, hit 10/9

Position: 2010 $120 LEAP Call WSD-AD @ $23.75


JPM $35.43 -$3.90 - JP Morgan

No real news. They did not file bankruptcy, they were not taken over and the Fed picked them to handle $540 billion in money market bailouts. It was a good week.

Earnings: Oct 15th @ 11 cents

Breakdown trigger: $40. Hit 10/6

Position: 2010 $50 LEAP Call WJP-AJ @ $6.00


XLF $13.55 $-1.80 - Financial SPDR

Still holding above the Oct 10th low and hopefully next week will be an up week with the PNC transaction in the bag.

Breakdown trigger: $17, hit 10/6

Position: 2010 $20 LEAP Call WFS-AT @ $3.00

Leaps Trader Watch List

Dropped Entries


New Watch List Entries


Current Watch List



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