The LEAPS Trader
105 W. Monument Street
Baltimore, MD 21201
Monday, October 16, 2006
Email – #342
** Reversal of Fortunes
Natural Gas futures spiked over 6% today on the anticipation of a colder-than-expected winter. This past weekend, two feet of snow fell on Buffalo and 500,000 people around Lake Ontario lost power.
Natural gas prices rise and fall on perception of weather, not necessarily on actual inventories. All it takes is a couple of really cold snaps or a threat of a major hurricane to send prices to the moon.
This year, weather forecasters are predicting a warmer-than-normal winter. However, they also predicted a more active hurricane season… and that prediction fizzled badly. Are there any bets on how their predictions of the weather this winter will work out?
Our natural gas play, the Chesapeake Energy (NYSE: CHK) spread, is down on the side of the long calls that we bought, but up on the calls that we sold.
In a spread, we took two positions. In this case, we bought the January 2008 $35 calls, and sold the $45 calls. The sell of the $45 calls acts as a hedge, in case the price of the shares goes down, because the price of the $35 calls will also decline as shares go lower. So… if the $35 calls decline in price, and the $45 calls decline in the price, the decline in price of the $45 calls offsets some of the loss of the $35 calls.
However, we can actually benefit from this position if we have time on our side. If we buy back the $45 calls at lower prices, we can actually increase the upside of the $35 calls because we have removed the cap that was implemented by the original spread trade. And we will have made money on the $45 option.
Here is how it works in number terms:
When we sold the $45 calls (WZY-AI), we received $2.80 (or thereabouts). Today, we can buy back the same option for $0.85. The net result is that we will make 70% on this side of the trade. Our expectation is that Chesapeake will rally between now and the next hurricane season, allowing us to cash in on the long side of the trade… which we will now own hedge-free by holding on to the $35 call option.
Action To Take:
Buy back the Chesapeake January 2008 $45 call option (WZY AI) and lock-in profits of 70% or thereabouts. This will leave you long the Chesapeake January 2008 $35 call option (WZY AG).
Good Investing,
Karim Rahemtulla
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Current Portfolio:
Company / Symbol: Nordstrom (NYSE: JWN)
Option / Symbol: Jan. 08 $40 put (YJY MH)
Date Purchased: 9/26/06
Current Price: $3.10
Comment: Hold.
Company / Symbol: Equity Office Properties (NYSE: EOP)
Option / Symbol: Jan. 09 $30 put (OLH MF)
Date Purchased: 6/22/06
Current Price: $1.20
Comment: Hold.
Company / Symbol: Microsoft (Nasdaq: MSFT)
Option / Symbol: Jan. 08 $30 call (WMF AF)
Date Purchased: 8/8/05
Current Price: $2.25
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $12.10
Comment: Hold.
Bull & Bear Spreads
Company / Symbol: AMD Micro Devices (NYSE: AMD)
Option / Symbol: January 2009 $35 call (VVV AG)
Date Purchased: 6/21/06
Current Price: $4.60
Comment: Hold.
Company / Symbol: AMD Micro Devices (NYSE: AMD)
Option / Symbol: January 2009 $45 call (VVV AI)
Date Purchased: 6/21/06
Current Price: $3.60
Comment: Hold. Sold call against January 09 $35 call position.
Company / Symbol: CBOE Volatility Index (WCB: ^VIX)
Option / Symbol: Feb. 07 $15.00 call (VIX BC)
Date Purchased: 5/3/06
Current Price: $2.10
Comment: Hold
Company / Symbol: CBOE Volatility Index (WCB: ^VIX)
Option / Symbol: Feb. 07 $17.50 call (VIX BW)
Date Purchased: 6/14/06
Current Price: $1.50
Comment: Hold. Sold call against Feb. 07 $15 position.
Company / Symbol: GoldCorp (NYSE: GG)
Option / Symbol: Jan. 09 $30 call (OPJ AF)
Date Purchased: 6/9/06
Current Price: $5.00
Comment: Hold.
Company / Symbol: GoldCorp (NYSE: GG)
Option / Symbol: Jan. 09 $40 call (OPJ AH)
Date Purchased: 6/9/06
Current Price: $3.00
Comment: Hold. Sold call against January 09 $30 position.
Company / Symbol: Teva Pharmaceutical (Nasdaq: TEVA)
Option / Symbol: Jan. 08 $40 call (WTX AH)
Date Purchased: 5/23/06
Current Price: $3.40
Comment: Hold.
Company / Symbol: Teva Pharmaceutical (Nasdaq: TEVA)
Option / Symbol: Jan. 08 $45 call (WTX AI)
Date Purchased: 5/23/06
Current Price: $1.75
Comment: Hold. Sold call against January 08 $40 position.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $35 call (WZY AG)
Date Purchased: 4/25/06
Current Price: $2.85
Comment: Hold.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $45 call (WZY AI)
Date Purchased: 4/25/06
Current Price: $0.80
Comment: Buy back option.
Company / Symbol: Energy Select Sector SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (ORJ MM)
Date Purchased: 3/1/05
Current Price: $0.10
Comment: Hold.
Company / Symbol: Energy Select Sector SPDR (AMEX: XLE)
Option / Symbol: Sell Jan. 07 $37 put (ORJ MK)
Date Sold: 3/30/05
Current Price: $0.10
Comment: Hold. Sold put against January 07 $39 position.
