Option Investor

Weekly Newsletter, Saturday, 12/06/2008

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Table of Contents

  1. Commentary
  2. Portfolio Listing
  3. New Plays
  4. Existing Plays
  5. Watch List

Leaps Trader Commentary

Somebody Please Wake Me

I am having this terrible nightmare that oil is trading at $40 and gasoline retails for less than $1.50. Millions of barrels of current and future production are being taken offline for not being cost effective. Surely this is a nightmare and not reality.

Unfortunately it is reality and I want to buy oil stocks and futures so bad I can taste it but oil company CEOs are on TV saying it could go to $25. I feel like I have stepped through a time portal to 1998 all over again. Crude was $10 a barrel and production was being shut in all over the world. We know now what havoc that caused over the last eight years but it appears we are doomed to make the same mistake twice.

I am going to reprint three paragraphs from my market wrap this weekend for the benefit of those readers who don't get that newsletter. Just skip three paragraphs if you read it there.

The most amazing statistic from last week came from the energy sector. The price of oil closed at $55.19 on Friday before last Saturday's OPEC meeting. This Friday it traded as low as $40.50 for a -26.6% drop. Given the prior $100 drop over the last few months this additional $15 drop in one week is nothing short of amazing. Actually it is incredible. OPEC did not act but made it clear they would in two weeks at the Dec-17th meeting. Unfortunately that is not the problem. We are still seeing massive liquidation by funds and institutions. Complicated hedges are being unwound on a daily basis as analysts talk about $25 oil and $1 gasoline. The world has gone mad as the fear of the recession has surpassed the actual impact of the recession. Just like every bubble is built on irrational expectations and greed, every crash is based on irrational expectations and fear. Every prediction by a major analyst is repeated thousands of times until another analyst jumps in the spotlight with something even more bearish and the actions are repeated. It is a massive game of whispers, gossip and unknowns. Nobody knows what demand will be in six months. Heck, nobody really knows what demand is now. Everyone is afraid the soaring unemployment will result in bread lines around the world and people will be living in their cars not driving them. All of this crap is simply not true. Even if demand temporarily fell another million or even two million barrels a day it is not the end of the world.

All of this hysteria over falling oil prices is doing much more harm than good. Projects are being cancelled or put on hold all over the world because the current price of oil does not support new projects to produce $50, $60 or even $75 oil. Every project that goes inactive adds several years to the date when it will eventually produce oil. We are already talking about projects that total over 3 mbpd of potential production. That production is what would have delayed the onset Peak Oil. By putting them on hold the world is becoming increasingly at risk of even higher oil prices. The recession will be over in 6-9 months and demand will explode at these low prices. Unfortunately when a project is cancelled or mothballed the workers move on to other jobs. The equipment is sent to other locations and pipe and supplies are diverted elsewhere to be used on other projects. When the decision is made to reactivate the project all those assets will need to be acquired again and that could take years in the case of rigs and workers.

The current drop in oil prices is the worst thing that could happen to the energy sector. We are duplicating exactly what happened 10-years ago this month. The price of oil crashed because of a political battle inside OPEC and Saudi Arabia flooded the market and pushed the price down to $10 a barrel to force other OPEC nations to face reality. Around the world rigs were mothballed by the thousands and eventually cut up for scrap steel. Tens of thousands of experienced oil field workers were laid off and either retired or went into other professions. These were experienced workers that could not be replaced. When the price of oil eventually began to rise again those workers were no longer available. The rigs had been scrapped and there was nobody left to man them even if they were still around. This led to a boom in the oil equipment sector where companies ended up with multiyear backlogs for new rigs. Day rates for existing rigs exploded. New workers had to be hired and trained at great expense. The result of the oil crash meant every new rig and crew now cost up to ten times as much to operate as the older rigs and hands. This meant the cost of producing a barrel of oil soared to levels today of $50, $60 or even $75 a barrel. Those fields cannot be produced today because they are not profitable and will eventually be shut in if prices do not change quickly. In 1998 thousands of producing wells were plugged because they were not profitable. Most were not reopened even at $145 a barrel simply because there was no time or money to do it. We lost millions of barrels of production because of low prices. The same thing is happening today. This oil crash will eventually turn around and when it does the moves are going to be dramatic. Enjoy your $1.50 gasoline today because it is not going to last forever.

There are so many oil stocks I want to buy but their charts are diving so fast I could lose fingers trying to catch them. Eventually this will turn around but we have to let it play out first. We know the integrated oils like Conoco, Exxon, etc, are going to report monster drops in profit over the next quarter because of the drop in oil prices. Those stocks should get cheaper.

Until then I am going to continue to focus on what I would call fringe plays. I added a combination play and two more stock plays. It is hard to resist a $2 stock with a bright future. There is no time decay and no expiration date. If you would rather I not profile these low priced stocks send me an email using the link on this page and I will quit. Majority rules. I believe this is a once in a decade opportunity and we should profit from it. Buy them in your IRA and forget them.

I am close to finalizing the EOY special and hopefully it will be ready by next weekend.

Jim Brown

January Crude Futures Chart - Daily
[Image 1]
January Natural Gas Futures Chart - Daily
[Image 2]
January Gasoline Chart - Daily
[Image 3]

Portfolio Listing & Top Picks

Current Portfolio

Disclaimer: At any given time the author may have positions in any or all of any companies mentioned in the Leaps Newsletter.

Position Summary Table
Table lists CALLS/LEAPS only. Insurance puts, if applicable, are not shown.

[Image 1]

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.

Top Picks List
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New Plays

New Lows in Energy Provide Yet Another Buying Opportunity

New Energy Plays

CY - Cypress Semiconductor

Cypress is another stock that was crushed by the market decline and whose future is looking bright. The new administration is strong on solar and many states are now enacting laws and new stimulus to promote wider solar use. The stock is so cheap that options do not make sense so just buy the stock.

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. In September 2008, Cypress announced the acquisition of Simtek Corporation.

Options don't make sense on a $4 stock.

BUY Stock in CY currently $4.11

Chart of CY
[Image 1]

FSLR - First Solar

First Solar is widely believed to be the best of the solar stocks and trades at a high premium and is highly volatile. Buying LEAPS anywhere close to the money is extremely expensive. The way to capitalize on this is to sell options. I am using a put spread in this example but it could also be a naked put if you only do the sell side. The profit would spike significantly but there is added risk. You could also consider a covered call and buy the stock for the current $128 and sell the $150 covered call.

Company description:

First Solar, Inc. designs and manufactures solar modules using a thin film semiconductor technology. Its solar modules employ a thin layer of cadmium telluride semiconductor material to convert sunlight into electricity. It has long-term solar module supply contracts (the Long Term Supply Contracts) with 12 European project developers and system integrators. Its customers develops, owns and operates solar power plants or sells turnkey solar power plants to end-users that include owners of land, owners of agricultural buildings, owners of commercial warehouses, offices and industrial buildings, public agencies, municipal government authorities, utility companies, and financial investors that desire to own large scale solar power plant projects.

Covered Call

Buy 100 Shares FSLR currently $128
Sell 2010 $150 LEAP Call LZL-AA currently $40.70
Profit if called is $40.70 in premium + $22 in stock (49%)

Put spread:

Buy 2010 $100 LEAP Put LQM-MT currently $32.90
Sell 2010 $250 LEAP Put LZL-MJ currently $135.70, net credit $103

Chart of FSLR
[Image 2]

New Non-Energy Plays

BZH - Beazer Homes

Beazer posted a really lousy quarter last Tuesday but there is light at the end of the tunnel. The company said new orders had jumped +10% over the same period in 2007 and cancellations were down to 45.7% from 68.1% in the same period. Beazer builds a lower priced home averaging $248,700. Given the new tougher loan requirements and need for a bigger down payment the low priced home builders may see more business than the high ticket home like Toll Brothers builds at an average of $648,000. I may be jumping the gun here but with the stock price at $2 and less than the bid/ask spread of many LEAPS it is cheap. BZH has developments in 17 states and is not expected to need financial help or file bankruptcy. Also, the government is working on ways to subsidize housing and that would help the low priced builders more than the upper end of the spectrum.

Company Info:

Beazer Homes USA, Inc. (Beazer) is a diversified homebuilder. It operates in 17 states. The Company’s homes are designed to appeal to homeowners at various price points across various demographic segments and are generally offered for sale in advance of their construction. The Company acts as the general contractor for the construction of its projects. Its project development operations are controlled by the Company’s operating divisions, whose employees supervise the construction of each project, coordinate the activities of subcontractors and suppliers, subject their work to quality and cost controls and assure compliance with zoning and building codes. The Company also offers title insurance services to its homebuyers in many of its markets. On February 1, 2008, the Company discontinued homebuilding operations in Charlotte, North Carolina, Cincinnati/Dayton, Ohio, Columbia, South Carolina, Columbus, Ohio, Lexington, Kentucky, Colorado and Fresno, California

The stock price is so cheap that options don't make sense.

BUY STOCK in BZH currently at $2.15

Chart of BZH
[Image 3]

New Watch List Plays Triggered

UWM - ProShares Ultra Russell 2000 ETF

We got the breakdown to our $16 entry trigger more than once. It appears the Russell is trying to rally but just can't get over resistance. I was encouraged by the high close on Friday and hopefully a breakout is imminent.

Company 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

Breakdown trigger: $16, hit 12/1

Position: April $25 Call ULX-DY $2.55

Chart of UWM
[Image 4]

DIG - Proshares Ultra Oil & Gas

With oil at four year lows of $40 and a full OPEC meeting in ten days it should be time for speculation to appear. The move down after last week's mini meeting ended without a production cut was brutal. Hopefully the eventual rally will be equally as strong.

Company Info:

Ultra Oil & Gas ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the Dow Jones U.S. Oil & Gas Index.

Breakdown trigger: $30, hit 12/1

Position: MAR $35 Call DPB-CG $5.40

Chart of DIG
[Image 5]

AAPL - Apple Inc

Palm warned, Nokia said sales were ok then warned two days later. RIMM warned and crashed. Apple held its ground and said customers downloaded 100 million new apps over the last 4-weeks. The iPhone could not be more popular and once the market finds traction Apple will lead the Nasdaq out of the recession.

Company Info:

Apple Inc. designs, manufactures, and markets personal computers, portable digital music players, and mobile communication devices and sells a variety of related software, services, peripherals, and networking solutions. The Company sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers. In addition, the Company sells a variety of third-party Macintosh (Mac), iPod and iPhone compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals through its online and retail stores, , and digital content through the iTunes Store. It sells to consumer, small and mid-sized business (SMB), education, enterprise, government, and creative customers

Breakout trigger: $96, hit 12/03

Position: 2010 $120 LEAP Call WAA-AD $18.40

Chart of AAPL
[Image 6]

FLS - Flowserve

Flowserve was captive to the energy markets but it appears the worst may be over with a bottom at $40.

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.

Breakdown trigger: $45, hit 12/1

Position: April $55 Call FGV-DK (no leaps) $5.33

Chart of FLS
[Image 7]

Play Updates

700 Point Moves Still Wreaking Havoc

Dropped Plays

TS - Tenaris ** Stopped **

Energy Play Updates

TS $19.49 -1.54 - Tenaris *** Stopped ***

Tenaris broke support on the large market drop on Friday morning and quickly regained lost ground to finish positive for the day. Unfortunately it was enough of a dip to trigger our stop at 18.50. I will play is again if it moves over $25.

Breakdown trigger: $20, hit 11/19

Position: JUNE $25 Call TS-FE @ 4.80, exit $2.40, 12/5

SMG $30.19 -2.17 - Scotts Miracle Gro

Lots of volatility but SMG is still maintaining its upward trend. No change in play.

Breakdown trigger: $25, hit 11/21

Position: 2010 $30 LEAP Call WOF-AF @ $5.20

DWSN $16.66 -3.91 - Dawson Geophysical

DWSN gave back the $3.50 it gained in the prior week but is still respecting support at the Nov 21st lows.

Breakdown trigger: $22.50, 11/06

Position: MAR $30 Call DVQ-CF @ $2.05

Stock Positions

FTK $2.43 -$.58 Flotek

No change in play

Options on FTK cost nearly as much as the stock and time decay works against you. Just buy the stock. At $3 it is cheaper than any LEAP.

Position Stock of FTK @ $3.01

CLNE $4.89 +0.04 - Clean Energy Fuels

No change in play

Clean Energy is the leading provider of natural gas (CNG and LNG) for transportation in North America. It has a broad customer base in the refuse, transit, ports, shuttle, taxi, trucking, airport and municipal fleet markets, fueling more than 14,000 vehicles daily at over 170 strategic locations across the United States and Canada. With the sudden surplus of natural gas it will be easier to convince companies to switch to the cleaner, cheaper fuel. The Clean Truck Program at California's ports is planning to switch out 8,000 diesel trucks for Nat Gas trucks over the next five years. This is just one program and CLNE has a major jump on everyone else.

Options on CLNE cost nearly as much as the stock and time decay works against you. Just buy the stock. At $5 it is cheaper than any LEAP.

Position: Stock of CLNE @ $4.84

Non-Energy Positions

HPQ $33.53 -$1.75 Hewlett Packard

Sharp dip on Friday but HPQ quickly recovered. Just passing time until the market finds traction.

Breakdown trigger: $33, hit 11/25

Position: 2010 $40 LEAP Call WPW-AH @ $5.60

VIX 59.93 +4.65 - Volatility Index

The VIX closed at the low for the week on Friday but we still need a market breakout over current resistance to really take the VIX lower. Maintain the stop at 70.

Position: JAN $50 PUT VIX-MJ @ $3.90

Leaps Trader Watch List

New Watch List Entries

POT - Potash

XLE - S&P Sector SPDR

Current Watch List

FXI - iShares China Index

China has been hit hard by the global crash but their GDP is only expected to decline to around 7%. That is still twice anything the U.S. could even hope for over the next two years. China may be feeling our pain but they are still growing fast.

Company Info:

This ETF tracks the 25 largest and most liquid Chinese companies trading on the Hong Kong stock exchange. With assets of some US$3 billion, iShares FXI has its largest holdings in financial services (30%), energy (22%), telecommunications (21%), and business services (13%). iShares FXI has over 60% of its assets concentrated in its top 10 stocks. China Mobile (10.4%) and Petro China (9%) are its two largest holdings, followed by China Life Insurance (8%).

Breakout trigger: $29

BUY 2010 $35 LEAP Call YOF-AI currently $3.60 (11/30)

POT - Potash

POT raised its profit estimates to $12 for 2008 and $16 for 2009. People still need to eat in a recession.

Company Info:

Potash Corporation of Saskatchewan Inc. is an integrated fertilizer and related industrial and feed products company. The Company’s potash is produced from six mines in Saskatchewan and one mine in New Brunswick. Of these mines, it owns and operates five in Saskatchewan and the one in New Brunswick. Its nitrogen operations involve the production of nitrogen fertilizers and nitrogen feed and industrial products, including ammonia, urea, nitrogen solutions, ammonium nitrate and nitric acid. It has nitrogen facilities in Georgia, Louisiana, Ohio and Trinidad. The Company’s phosphate operations include the manufacture and sale of solid and liquid phosphate fertilizers, animal feed supplements and industrial acid, which is used in food products and industrial processes. It indirectly holds all outstanding interests in PCS Joint Venture, Ltd., which formerly manufactured, processed and distributed fertilizer and other agricultural supplies from plants located in Florida and Georgia.

Breakdown trigger: $50

BUY 2010 $70 LEAP Call WPT-AN

Breakout trigger: $58

BUY 2010 $80 LEAP Call WPT-AP

XLE - S&P Energy SPDR

Company Info:

The S&P Energy sector SPDR represents about 13% of the S&P-500. Energy companies in this Index primarily develop and produce crude oil and natural gas, and provide drilling and other energy-related services. Leaders in the group include ExxonMobil Corp., Chevron Corp, and ConocoPhillips.

Breakdown trigger: $41

BUY 2010 $50 LEAP Call WHA-AX

Dropped Watch List Entries



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