The LEAPS Trader
105 W. Monument Street
Baltimore, MD 21201
Tuesday, April 25, 2006
Email – #311
** Gapping the Divide
Oil prices are touching $75 for the June contract. Meanwhile, natural gas is bouncing off its near-term lows at $7 to $8, after hitting $15 last year when the hurricanes hit in the Gulf of Mexico.
Such a disparity is not normal. In recent history, “natty” has traded at a ratio of about 6 to 1 against the price of crude. Today, that ratio is at about 9 to 1. This implies that either oil is prone to a 40% collapse, or natural gas has a ways to run.
Technically speaking, I have received two strong signals, one from a colleague who is a technical trader and the other from a colleague who is a former NYMEX trader. Both are in agreement that “natty” is making a base in the $7s and has likely bottomed. While I am not a chartist, I do have confidence in their abilities.
From a fundamental point of view, there are no shortages of natural gas. But the same can be said for crude oil, as well. Oil is sporting a huge geopolitical premium that does not look to go away soon. Natural gas is sporting a small energy “me too” premium that appears to be on the increase again. And, natural gas is entering two important parts of the year.
First, it is almost summer, and energy demand will increase substantially if it is a hot one. Second, there is a hurricane play. I believe the first major hurricane this year will send prices higher in a hurry as ghosts of lasts year’s destruction come to mind.
Chesapeake Energy (NYSE: CHK) is not an unfamiliar holding to use, but is one of the premier low-cost explorers and producers of natural gas in the world with a low-cost reserve base. The company’s CEO has been buying shares at current levels of $32.75 and higher. This year, the company is slated to earn more than $3 per share, bringing its P/E to under 11… for a company that has the potential to grow its revenues 30% to 50% if the price of gas moves back to its post-Katrina highs. Chesapeake does hedge a chunk of its production, so revenues do not move in lockstep with the price of the underlying commodity.
Here’s how to play this potentially explosive 20% to 30% move in natural gas prices.
We will initiate a bull spread on Chesapeake Energy (NYSE: CHK). Buy the January 2008 $35 LEAPS (WZY AG) at current prices of $6.40. Against this position, SELL the January 2008 $45 call options (WZY AI).The current price on this option is $3 on the bid. Your cost of the spread should be about $3.40 with a $10 spread, or 3-to-1 profit potential if CHK closes above $45 in January 2008.
Of course, our plan is to cover early. The CHK options are very expensive, so I am recommending the spread strategy to keep our cost under control while preserving a huge upside as well. Execute this trade as long as your cost of doing the spread (premium to buy the $35 option minus the premium received from selling the $45 option) does not exceed $3.50.
This is a “flyer” pick on natural gas. It is speculative and it will be volatile as well.
Current Portfolio:
Company / Symbol: sanofi-aventis (NYSE: SNY)
Option / Symbol: Jan. 08 $60 call (WFK AL)
Date Purchased: 4/17/06
Current Price: $2.55
Comment: Hold.
Company / Symbol: Boston Scientific (NYSE: BSX)
Option / Symbol: Jan. 08 $30 call (WBX AF)
Date Purchased: 2/27/06
Current Price: $1.90
Comment: Hold
Company / Symbol: Target (NYSE: TGT)
Option / Symbol: Jan. 08 $50 put (WDH-MJ)
Date Purchased: 10/20/05
Current Price: $4.35
Comment: Hold.
Company / Symbol: Microsoft (Nasdaq: MSFT)
Option / Symbol: Jan. 08 $30 call (WMF AF)
Date Purchased: 8/8/05
Current Price: $2.10
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $11.45
Comment: Hold.
Bull & Bear Spreads
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $35 call (WZY AG)
Date Purchased: New
Current Price: $6.40
Comment: Buy.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $45 call (WZY AI)
Date Purchased: New
Current Price: $3.00
Comment: Sell call against January 08 $35 position.
Company / Symbol: Couer D’Alene (NYSE: CDE)
Option / Symbol: Jan. 08 $7.50 call (LGZ AU)
Date Purchased: 3/27/06
Current Price: $2.30
Comment: Hold.
Company / Symbol: Couer D’Alene (NYSE: CDE)
Option / Symbol: Jan. 08 $10 call (LGZ AB)
Date Purchased: 3/27/06
Current Price: $1.85
Comment: Hold. Sold call against January 08 $7.50 position.
Company / Symbol: Nasdaq 100 Trust (Nasdaq: QQQQ)
Option / Symbol: Jan. 07 $42 put (VCQ MP)
Date Purchased: 2/1/06
Current Price: $1.85
Comment: Hold.
Company / Symbol: Nasdaq 100 Trust (Nasdaq: QQQQ)
Option / Symbol: Sell Jan. 07 $38 put (VCQ ML)
Date Purchased: 2/1/06
Current Price: $0.85
Comment: Hold. Sold put against January 07 $42 position.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (ORJ MM)
Date Purchased: 3/1/05
Current Price: $0.20
Comment: Hold.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Sell Jan. 07 $37 put (ORJ MK)
Date Sold: 3/30/05
Current Price: $0.20
Comment: Hold. Sold put against January 07 $39 position.
