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MTG - $64.32 - M.G.I.C. Investment Corp ** Stop $68.00 **

Post earnings depression has hit MTG and we saw a new three-month low on Friday at $63.94. Nothing has changed with MTG and once under the 100 and 200-day averages at $63.80 we could see a significant drop. The key words here are "once under." This could be material support and provide a bounce. Maintain the stop and let's see if we get lucky.


Original play description:

MGIC provides mortgage insurance to lenders for borrowers with high loan to value ratios. The borrower pays the mortgage protection insurance premiums with their monthly payment. With the very high loan to value mortgages of the last couple years MGIC has a rising risk of default. Earnings were on Thursday and revenue fell -8% along with a net decrease in premiums received of -8.2%. New insurance written also fell. The percentage of delinquent loans at year-end rose to 4.52% from 3.99%.

I know several homeowners, three in the same block, that are only days/weeks away from foreclosure and everyone had taken advantage of the accelerating home values to refi, some more than once. Home values have fallen nearly -20% in this Colorado area despite what you read in the papers. The foreclosure boom is coming and MGIC will suffer.


Company Info:

MGIC Investment Corporation is a holding company that, through its wholly owned subsidiary, Mortgage Guaranty Insurance Corporation (MGIC), provides private mortgage insurance in the United States to the home mortgage lending industry. Its principal products are primary mortgage insurance and pool mortgage insurance. Primary mortgage insurance may be written on a flow basis, in which loans are insured in individual, loan-by-loan transactions, or may be written on a bulk basis, in which a portfolio of loans is individually insured in a single, bulk transaction. It is licensed in all 50 states of the United States, the District of Columbia and Puerto Rico. In addition to mortgage insurance on first liens, the Company provides lenders with various underwriting and other services and products related to home mortgage lending through other subsidiaries.

Buy 2008 $65 LEAP Put YHM-MM currently $6.50
(No 2007 $65 put exists)

Insurance Call: None

Entry $67.22 (01/15)

LEND - $52.32 - Accredited Home Lenders ** Stopped $52 **

That was not fun. LEND spiked nearly +$5 on Monday and took us out of the play at the $52 stop. Unfortunately I believe LEND is vulnerable at that $52 level and would like to keep playing it but we have a good position in MTG using the same logic. Let this one go and keep MTG.


Original play description:

LEND is a sub-prime mortgage lender. Another way to put that would be to say they lend money to those with weak credit. If the housing market is really slowing and housing values declining then sub-prime lenders could be in trouble.

We have already seen mortgage application rates sink to levels not seen since 2004. The Mortgage Application Index decreased to 545.9 last week, -17% below the level from just four weeks ago and more than 10% below the same period in 2004. Refinancing has fallen to levels -20% below 2004 levels.

The days of the mortgage-refi to get out of debt are gone. Tighter loan restrictions and higher default rates are commonplace across the country. I have a son in the mortgage business and he claims applications have fallen through the floor and restrictions are rising. Borrowers who refied a year ago can't get an approval today despite substantial equity left in their homes.

Option loans, where the lender gives the borrower a smaller payment for the first 2-3 years have evaporated. Even ARM loans are falling, down -4% in the latest numbers.

Ironically Fannie Mae and Freddie Mac raised the limits for conforming loans by +16% as of Jan-1st. This means the conforming loan limit for a single-family property rose from $359,650 in 2005 to $417,000 as of Jan-1st. This should increase the level of loans except that property values are slowing and credit criteria is rising.

The Mortgage Bankers Association expects loan originations to fall by -18.6% in 2006.

In October National City said loan profits fell -91% over the same period a year earlier. H&R Block blamed a $86 million loss on a drop in income from its mortgage unit.

If this trend continues sub-prime lenders may have to set aside more money as reserves to cover defaults at a time when loan initiation profits are also shrinking. The smaller pie available to all lenders is making competition for loans even more cutthroat. Many lenders MUST do loans to survive and they will be forced to take lesser credits, greater risks and receive less income for those risks.

Lenders are already slashing staff in an effort to maintain profitability.

LEND published an earnings outlook on Dec-19th for Q4. They said they expected to earn $7.70 to $8 per share compared to analysts estimates of $7.74. HOWEVER, Accredited Chairman and Chief Executive James Konrath said that the projected earnings target depends largely on pricing in the nonprime mortgage market and assumes growth in loan originations but lower costs of origination. That is a very big IF. I could make a million dollars next month if I could pick the exact top in January and then short 1000 SPX futures contracts. That is not going to happen. LEND may reach its targets but there is still trouble ahead.

I am only using a June Put option on this play despite LEAPS being available. All lenders will see a spike in loans in April/May as the summer selling season arrives. I would like to be out by then.


Company Info:

Accredited Home Lenders Holding Co. (Accredited) engages in the business of originating, financing, securitizing, selling and servicing non-prime mortgage loans secured by residential real estate in the United States. Accredited focuses on borrowers who may not meet conforming underwriting guidelines because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, or past credit difficulties. The Company originates loans primarily based upon the borrower's willingness and ability to repay the loan and the adequacy of the collateral. Accredited originates its loans primarily through independent mortgage brokers across the United States and, to a lesser extent, through its direct sales force in its retail offices.

Buy June $45 Put QFW-RI currently $4.70, exit $3.00, 01/30

No Insurance:

Entry $47.45 (01/08)

FCX - $61.71 - Freeport McMoran ** Stop Loss $58 **

FCX hit a new high on Wednesday before pulling back nearly -$4. I considered closing it but a weak market, rising inflation and instability over Iran's future should continue to put upward pressure on gold prices. Should oil fall off a cliff there would be fewer petrodollars going into gold but I believe it would be short lived. I am going to keep the faith here until gold stumbles. I did raise the stop loss.

Company Info:

Freeport-McMoran Copper & Gold Inc. is a copper and gold mining and production company. The Company's principal asset is the Grasberg mine. Grasberg contains gold reserve and copper reserves. Its principal operating subsidiary is PT Freeport Indonesia. The Company owns approximately 90.64% of PT Freeport Indonesia, and the Government of Indonesia owns the remaining approximate 9.36%. PT Freeport Indonesia mines, processes and explores for ore containing copper, gold and silver. It operates in the remote highlands of the Sudirman Mountain Range in the province of Papua, Indonesia, which is on the western half of the island of New Guinea. PT Freeport Indonesia markets its concentrates containing copper, gold and silver worldwide. The Company also smelts and refines copper concentrates in Spain, and markets the refined copper products through Atlantic Copper, S.A., the wholly owned subsidiary of the Company among others, such as PT Irja Eastern Minerals and FM Services Company


2007 $55 LEAP Call OMT-AK @ $6.00

Insurance put: Cancelled - not triggered 1/29
(Feb $50 FCX-MK if FCX trades @ $53)

Entry $52.00 (12/21)

VLO - $58.70 Valero ** No Stop **

VLO reported record earnings of $1.35 billion for the quarter and predicted 2006 would be the best year ever. The CEO said Valero was open to another acquisition but the offerings were slim. A quick search suggested SUN, HOC and GI could be in their sights. All were added to the watch list today.

VLO spiked to $63.70 on the earnings news and a new all time high. The drop in oil prices and the post earnings depression sent it plunging back to $58. The insurance scenario worked out very well. We are now covered by a March put with a very good chance of a nearly free trade if our profit target on the put is hit.

The insurance I recommended last week end worked perfectly. The gap open on Monday allowed us to sell the March $65 call for $2.70 assuming you waited for the initial gap open to slow or as much as $3.30 is you waited for the spike to cool. The same gap open pushed the protective put lower to a range of $1.45 to $1.90. Using an average price of $2.50 on the call and $1.60 on the put we ended up with a net gain of +0.90 cents and now have insurance of a March $57.50 put. That put is now worth $2.75 and the call $1.40. I am recommending we buy back the call on Monday at $1.40 and after our net gain of +90 cents on the initiation of the insurance position we now have a cost in the put of 50 cents. Should VLO continue lower we can sell the put for a profit to further reduce our cost in the LEAP. Target VLO at $54 to exit the put. Otherwise it will remain insurance until it expires.


Company Info:

Valero Energy Corporation (Valero) owns and operates 18 refineries having a combined throughput capacity, including crude oil and other feedstocks, of approximately 3.3 million barrels per day. Valero produces environmentally clean refined products, such as reformulated gasoline (RFG), gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen). It also produces conventional gasoline, distillates, jet fuel, asphalt and petrochemicals. Valero markets branded and unbranded refined products on a wholesale basis in the United States and Canada through a bulk and rack marketing network. It sells refined products through a network of more than 4,700 retail and wholesale branded outlets in the United States, Canada and Aruba. Valero's retail operations include approximately 1,500 company-operated sites that sell transportation fuels and convenience store merchandise.

2007 $60 LEAP Call VHB-AL @ $6.60

Insurance Put: March $45 Put VLO-OI @ $1.20
Put entered on 12/27 when VLO traded at $51

Monday Feb-6th:

Close the March $65 Call VLO-CM currently $1.40
Set a profit target on the March $57 put at $54

Monday Jan-30th:

Sell March $65 Call VLO-CM currently $1.75 bid
Buy March $57.50 Put VLO-OY currently $2.40 ask
Set a stop loss on the call at $64. Profit stop at $54
Set a profit stop on the put at $52.

Entry $52.30 (12/16)

OSTK $23.88 - Overstock.com ** Closed **

Overstock finally announced a date for their earnings of Feb-7th. While I think it is an opportunity for a real implosion I am leery of the sudden price spikes whenever OSTK releases a press release. They are constantly trying to spin the news away from their problems in towards the naked shorting they claim is hurting their stock price.

According to their last filing with the SEC they lost -$18.41 million for the 12 months ended on Sept 30th. They have already warned that they had a bad Q4 and software problems have prevented them from uploading new merchandise to the website for the last five weeks. They are burning cash at a horrendous rate of -$28.15 million over the last period reported compared to only -$9.53 million in the same period a year earlier.

While I believe Overstock will eventually implode or be taken over by somebody like Amazon or Yahoo I do not want to risk our gains over an earnings report. The stock is so depressed even a whiff of fresh air could send it soaring.

Hold over earnings if you must but I am closing the play today and pocketing the gains. We entered the short at $38 and rode it to $23. No complaints here.


Play Description:

Probably the worst managed retail site on the Internet. The President, Patrick Byrne, blamed the poor performance of his stock on an evil "Sith Lord." (A Star Wars Character) Patrick continually ranks in the top five worst performing executives of a public company as rated by the Motley Fool. His latest claim to poor stock performance is the possible existence of "millions of counterfeit shares of OSTK trading on the Nasdaq." I am not kidding. He blames the SEC with being in collusion with the Nasdaq for refusing to disclose the number of counterfeit shares in the system. He warned "shareholders that their only prophylactic against hedge fund counterfeiting was to obtain the actual certificates from your broker and store them in a safe place." This would of course prohibit your shares from being traded. This was in response to a "Get Shorty" article in the WSJ.

Overstock has filed suit against several research firms claiming a conspiracy to drive its stock price down. Patrick claims research firm Gradient Analytics and Rocker Partners were at the center of a vast conspiracy aligned against Overstock. He warned that the criticism of Overstock.com will not go unpunished.

Patrick was forced to give up his role as Chairman in October with his father John Byrne taking back control. Patrick remains the president but that has not diminished his wild accusations.

The company has a good business model but has failed to execute on so many levels that it should be criminal. They have the worst customer service of any E-Commerce site I have every visited. I have made several purchases in the past from OSTK and all but one were botched terribly. The products come in an unlabeled box with no return address label and no invoice. You can't return them without some serious effort. Consumers will not put up with this when other companies like Amazon.com, NewEgg.com and Ecost.com are models for the industry.

Sales at OSTK have slowed and operating expenses are growing faster than revenue and marketing costs nearly doubled in Q3. Cost of acquisition for new customers rose +30% over the prior quarter. This is a signal that competition is winning the battle and prior customers are not returning. OSTK has a huge debt load and slowing sales will not help. Morningstar gives them a D+ for financial health and an F for profitability. Analysts are dropping estimates for the stock into the high $20 range and well below current prices.

In August, Patrick Byrne held a conference call in which he basically said that everyone from hedge funds to journalists to regulators had all been scheming to destroy his company. He said the plan was being orchestrated by someone he identified only as the "Sith Lord." He really said that. Rob Plaza at Zachs Investment Research said when a CEO is putting the focus on things he can't control like short interest there could be a bigger problem he does not want you to see. He said an even bigger problem is when management blames regulators for stock manipulation you have a real problem.

The last really dumb statement, or was it, came from Patrick on Nov-10th. He said "I don't give stock advice but the average investor should probably steer clear of Overstock." That advice I will follow.

Company Info:

Overstock.com, Inc. is an online closeout retailer, offering discount, brand-name merchandise for sale primarily over the Internet. The Company's merchandise offerings include bed-and-bath goods, home decor, furniture, kitchenware, watches, jewelry, computers and electronics, sporting goods and apparel and designer accessories. It also sells books, magazines, compact discs (CDs), digital versatile discs (DVDs), videocassettes and video games (BMV). The Company also offers limited travel services. Overstock.com offers approximately 50,000 non-BMV products and approximately 500,000 BMV products in eight departments on its main Website, www.overstock.com. Overstock.com has a direct business in which it buys and takes possession of excess inventory for resale. It also has another worldstock Website, www.worldstock.com, through which artisans in the United States and around the world can sell their products.

No LEAPS

June $35 Put QKT-RG @ $5.00, exit $12.50, +7.50, +150% 2/05

No insurance.

Entry $38.51 (12/12)

HW - $37.50 - Headwaters ** No Stop **

HW rebounded from the depths of obscurity at $31.50 over the last two weeks and closed Friday at $37.50. This remarkable recovery put it right back near the highs set in January at $38.34. While we are at risk for the covered call insurance I am not going to complain if a breakout occurs. The small loss on the call will be more than offset by the LEAP.

********

Headwaters (HW) has a compound annual growth rate of more than +120% mainly because it deals with the ash left over from burned coal. Coal generates a lot of ash and it is a problem the electric generating plants have to deal with when these cold fronts really suck up their coal supplies. Headwaters has three separate businesses from that ash. They have a business that buys and sells it for various purposes. Second they have produced a bonding agent to that makes it easy to transport without blowing out of the rail cars. They sell this to others for profit. Third they have a patented process for converting this ash into a synthetic fuel, which is licensed to plants that actually do the conversion.

They also make building materials and a cement substitute that uses this ash to make concrete more durable. Considering the thousands of tons of ash generated each week this appears to be a gold mine for Headwaters. When electric plants fight the tons of daily ash Headwaters is there to help and converts that ash back to dollars. This sounds too good to be true and I think that was the real problem with the decline from $46 in August to the $30 level in October. The ramp from IPO in April from $30 to $46 and decline back to $30 is complete. Those that got in on the good IPO story took their profits as energy prices declined. Now may be the time to jump back on the coal train with Headwaters rather than Peabody.

Company Info:

Headwaters Incorporated is a diversified company providing products, technologies and services to the energy, construction and home improvement industries. Headwaters conduct its business primarily through four business units, including Headwaters Resources, Headwaters Technology Innovation Group (HTI), Headwaters Construction Materials and Headwaters Technology Innovation Group. In September 2004, the Company acquired Tapco Holdings Inc., a manufacturer of building products and professional tools used in residential remodeling and construction. In June 2004, the Company acquired Eldorado Stone, LLC, a manufacturer of architectural manufactured stone based in San Marcos, California. Eldorado Stone is being purchased from Graham Partners, a middle-market private equity firm. Eldorado Stone will be integrated into Headwaters' coal-based construction materials operations.


2007 $40 LEAP Call ZPP-AH @ $4.30

Dec-27th Insurance Combo:
Sell May $40 Call HW-EH currently $2.05, set stop at $39.95
Buy May $35 Put HW-QG currently $2.15

Entry $35.50 (11/22)

CHK - $33.60 Chesapeake Energy ** No Stop **

CHK rallied to break the $35 level by +50 cents and stop us out of the covered call we added on 12/27. We lost -55 cents on the call but more importantly gave back the $2.15 in premium we had gained with the sale of the call. With gas prices likely to head south in about two weeks we will resell another call around the end of February to offset the cost of the leap while we wait for the summer surge.

There was no insider trading over the last week. Evidently the spike in price from $31 to $35 made them patient buyers. They realize gas prices are going to fall in March and they can afford to be patient.

The CEO said on Wednesday that CHK is more likely a buyer of other companies and assets than a target of a takeover itself. He said there were many potential targets smaller than Chesapeake and the drop in gas prices made them attractive. He said gas prices should remain in the $7.50-$10.50 range the rest of the year. He did not expect any major to make a big play like Conoco did when it purchased Burlington late last year for $35 billion. He also said CHK's $2.2 billion acquisition of Columbia Natural Resources was going better than planned and the opportunity appears to be bigger than originally thought. McClendon said CHK had actively hedged its output when prices were higher and were profiting from the swings in prices. He said the plunge in gas prices was "fantastic" because it made acquisitions cheaper, stemmed demand destruction and gave consumers a break on their utility bills. CHK also announced the private placement of $500 million in 6.5% notes due in 2017. The proceeds would be used to pay off bank debt. What a deal! Gas will be $30 by then and the $500 million plus interest will be chump change.

Insider Trading:

A reader alerted me to the insider buying on CHK, (thanks Joe!) and I must say it is amazing. The Chairman and the President made a total of 18 market buys between Dec-14th and Jan-25th totaling over $82 million. That is an obscene amount of confidence and suggests to me that something is going on at CHK and their outlook is extremely positive. With a market cap of $11 billion they could be a takeover candidate made much more possible by being the third largest holder of gas reserved in the U.S.

Company Info:

Chesapeake Energy Corporation is an oil and natural gas exploration and production company engaged in the acquisition, exploration and development of properties for the production of crude oil and natural gas from underground reservoirs and the marketing of natural gas and oil for other working interest owners in properties that it operates. The Company's properties are located in Oklahoma, Texas, Arkansas, Louisiana, Kansas, Montana, Colorado, North Dakota and New Mexico. The proved oil and natural gas reserves as of December 31, 2004 were approximately 4.9 trillion cubic feet of gas equivalent (tcfe). At December 31, 2004, approximately 89% of the Company's proved reserves (by volume) were natural gas, and approximately 70% of its proved oil and natural gas reserves were located in the primary operating area, the Mid-Continent region of the United States, which includes Oklahoma, western Arkansas, southwestern Kansas and the Texas Panhandle.

2007 $35 LEAP VEC-AG @ $4.00

Insurance Put:
April $25 CHK-PE when CHK traded at $28 on 11/07 @ $2.30

Covered Call 12/27:
Sold the April $35 Call CHK-DG currently $2.15
Set a stop loss on the call at $34.95, exit @ $2.70, -55, 1/30


Entry $29 (11/04)

 

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