The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Tuesday, March 1, 2005
Email – #235
** Oil’s Well… Or Is It?
Oil is a very interesting commodity. It has almost inelastic price qualities. Higher prices don’t really dampen demand in the short term because people and industry need oil to survive and thrive.
But oil is also self-limiting when it gets too high in price. People start cutting back because it becomes too expensive to fill up that SUV every week. Business begins to raise prices or face margin pressure.
The economy at some point either succumbs to inflation or dives into recession. Either scenario makes oil weaker, since it will impact demand.
Then you have the weather. Fortunately, the weather does change and when spring and summer arrive, oil prices are usually less dependent on the weather forecast.
Finally, you have two other sources of pressure on oil. First is exploration and new discovery. And second (and more important) is the competive pressure that arises from alternative sources of energy when the price of oil gets too high. What can’t be controlled, however, is politics.
Much of the move in oil prices is due not so much to demand factors; rather, its based more on a potential oil shortage caused by events in the Middle East, or in “Chaostan,” as one well known editor calls the region.
Then there is China. China has increased oil imports, but it also faces the possibility of a mega bubble popping if it continues its easy money policy. I mean, you can borrow money in China at similar rates as in first-world, established, democratic economies with a history of legitimate business practices. Something is out of whack here and it does not bode well if the spigots are not tightened soon.
So how do you play oil? Do you go long or short at $52 a barrel? In the past you had little choice of vehicles. You could trade oil futures or you could short an oil stock. Today we are going to go short oil with a horizon of almost two years with a vehicle that mimics the price movement in oil.
Why are we going short? I believe that over the next two years we will see oil prices move lower at some point to the $45 level – about where it was a few weeks ago. If it goes lower, we make more. If it goes higher, we will lose some money.
Here is how to do it. There is a new ETF that consists of oil companies, drillers, explorers and refiners. While their businesses succeed and do well as long as oil is high, their prices are based on a continued rise in oil prices or stability at the current levels.
What’s interesting is that when oil falls, this index falls in unison. It is the Energy Select Sector SPDR, symbol XLE and it trades on the American Stock Exchange. What’s better is that is has LEAPS that will allow us to short oil for almost two years at a massive discount to actually trying to short oil or the index.
Action To Take:
Buy the Energy Select SPDR (AMEX: XLE) January 2007 $39 PUT option (ORJ MM). It is currently trading at $2.35 and is VERY liquid. Do not pay more than $2.45.
And remember, the price will go down if oil goes up and should go higher if oil goes lower. Be patient on trading this option and use LIMIT orders to get filled. Unless oil crashes today, you should have no trouble getting filled. Use at MENTAL stop-loss of $1.20. A 10 – 15% move down in the price of oil – to about $45, should result in a 50 – 70% gain in the price of this option.
Regards,
Karim Rahemtulla
Current Portfolio:
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (ORJ-MM)
Date Purchased: New
Current Price: $2.35
Comment: Buy. Don’t pay more than $2.45. Use a mental sell stop of $1.20.
Company / Symbol: Comcast (Nasdaq: CMCSA)
Option / Symbol: Jan. 07 $35 call (VPK-AG)
Date Purchased: 2/16/05
Current Price: $3.60
Comment: Hold. Mental sell stop is $1.95.
Company / Symbol: AngloGold/Ashanti (NYSE: AU)
Option / Symbol: Jan. 07 $40 call (VKE-AH)
Date Purchased: 1/5/04
Current Price: $4.80
Comment: Hold.
Company / Symbol: General Electric (NYSE: GE)
Option / Symbol: Jan. 07 $40 call (VGE-AH)
Date Purchased: 1/4/04
Current Price: $1.75
Comment: Hold.
Company / Symbol: Daimler Chrysler (NYSE: DCX)
Option / Symbol: Jan. 07 $40 put (VLN-MH)
Date Purchased: 11/30/04
Current Price: $2.50
Comment: Hold.
Company / Symbol: Intel (Nasdaq: INTC)
Option / Symbol: Sell Jan. 06 $25.00 call (WNL-AE)
Date Purchased: 11/2/04
Current Price: $2.25
Comment: Hold. Sold call against Jan. 06 $22.50 position.
Company / Symbol: Intel (Nasdaq: INTC)
Option / Symbol: Jan. 06 $22.50 call (WNL-AX)
Date Purchased: 10/19/04
Current Price: $3.80
Comment: Hold.
Company / Symbol: Interactive Corp. (Nasdaq: IACI)
Option / Symbol: Sell Jan. 07 $30 call (VSW-AF)
Date Purchased: 12/10/04
Current Price: $1.35
Comment: Hold. Sold call against Jan 07 $25 position.
Company / Symbol: Interactive Corp. (Nasdaq: IACI)
Option / Symbol: Jan. 07 $25 call (VSW-AE)
Date Purchased: 9/14/04
Current Price: $3.20
Comment: Hold. No TS.
Company / Symbol: Nokia (NYSE: NOK)
Option / Symbol: Sell Jan. 06 $30 call (WIK-AF)
Date Purchased: 2/9/04
Current Price: $0.10
Comment: Hold. Sold call against Jan. 06 $22.50 position.
Company / Symbol: Nokia (NYSE: NOK)
Option / Symbol: Jan. 06 $22.50 call (WIK-AX)
Date Purchased: 8/29/03
Current Price: $0.15
Comment: Hold. No TS.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Sold Jan. 06 $15 call (WZY-AC)
Date Purchased: 11/6/03
Current Price: $6.80
Comment: Hold. Sold call against Jan. 06 $12.50 position.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 06 $12.50 call (WZY-AV)
Date Purchased: 7/28/03
Current Price: $9.30
Comment: Hold. No TS.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $10.61
Comment: Buy under $10. No TS.
Bio:
Karim Rahemtulla is the former Investment Director of The Oxford Club. The editor of The Smart Options E-Report, The Income Trader – A Covered Call Strategy and The LEAPS Option Trader, Karim is also a regular contributor to The Oxford Club Communiqué. His highly successful trading systems use covered calls and LEAPS to boost returns on blue chip stocks, and during the bear markets of 2000 and 2001, his picks outperformed the major market averages. Educated in England, Canada and the U.S. and fluent in several languages, Karim travels the world to find the best investment opportunities for our members.
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