The LEAPS Trader
105 W. Monument Street
Baltimore, MD 21201
Friday, January 19, 2007
Email – #354
** Which Way Is Up?
Oil has fallen almost 35% from its mid 2006 highs. And oil stocks have followed.
However, the fundamentals that have driven the price of oil higher have not changed much since last year. The BRICs are still growing… the Middle East is out of control… the US economy, while slowing, is not crashing. The only changes have been investor sentiment and the weather. Talk about two variables that are hard to predict or measure!
This morning one of oils bell weathers, Schlumberger (NYSE: SLB) reported that it’s seeing continued strong demand for its oil services products. So much so, in fact, that it’s increasing its dividend by 40%. And, while the company doesn’t see a shortage of oil, it does see the cost of producing oil increasing, as the reserves that are out there are of poorer quality and cost more to get out of the ground, for oil and natural gas.
Schlumberger has seen huge increases in revenues over the past three years. And, the company forecasts a continued growth spurt well into the end of the decade.
Time To Go Long
I’ve been cautious on oil for much of the past year. We even made money shorting the XLE, and one of our oil spreads expiring this week was a bear spread. Now, I think it is time to take on some risk and go long using the LEAPS spread strategy. This will allow us to bet on oil and oil services through Schlumberger without risking the $60 entry price.
Nobody can call a bottom in oil. Just yesterday, Jim Rogers stated that he sees this as a temporary pullback on the way to $100 per barrel. Meanwhile, ten other analysts predicted that oil was heading back to $30. That’s a $70 spread in opinion. We’ve stayed out of the oil fray for a while, thanks in part to advice from Lee Lowell, one of the members of our advisory team, who’s a long time trader and market maker on the NYMEX.
With oil, any given headline could cause a major disruption in the oil market. Rumblings in the Straits of Hormuz… political action to increase production costs for oil drillers for clean air concerns… more capital costs for drilling in tougher places. You name it. This $28 drop in oil prices has been sharp and sudden – maybe too sharp. Much of the speculative froth that was present last year has all but vanished as traders and investors have headed for the exits. But, as I mentioned earlier, what has really changed?
Limit Risk With LEAPS
We’re going to make a bet on oil, but we’re going to limit our risk by using LEAPS, and use a spread to further defray our exposure. In addition, we’ll be investing in an oil services company, as opposed to a pure oil play.
Companies like Schlumberger make money by providing the tools and expertise to find and get oil out of the ground worldwide. Lower prices hurt, but this company was printing money when oil was at $25 per barrel. Now it’s at $50, down from $78. Growth will slow, but not to the extent that many investors have figured, knocking 25% off the share price. Still, the risk is there, and notwithstanding the company’s bullish prospects and comments from this morning, investing in commodities and commodity-related stocks is not for the faint-hearted.
Here is what we are going to do to try and double our money this year from Schlumberger:
Buy the Schlumberger January 2008 $60 call LEAPS (WUB AL), currently trading at $8.50.
Against this position, SELL the Schlumberger January 2008 $65 call LEAPS (WUB AM) currently selling for $6.
Your cost for this spread is going to be $2.50 at current price with the chance to make $5 (the spread) or 100% on your investment.
Now, oil is going to fluctuate in the coming days and weeks, and the price of SLB will fluctuate as well. It is critical that you DO NOT PAY more than $2.50 for this spread. You will likely get filled for less if you are patient, or place orders in between the bid and offer.
So, DO NOT CHASE this play. Use $2.50 as your guideline. We’re looking to exit the shares by the end of summer – in the middle of hurricane season and during the summer driving season… if not sooner. If the price of oil tanks more, we may cover the upper part of the spread.
Good trading,
Karim
Current Portfolio
Company / Symbol: Pep Boys (NYSE: PBY)
Option / Symbol: Jan. 08 $10 call (KSY AB)
Date Purchased: 1/9/07
Current Price: $5.90
Comment: Hold.
Company / Symbol: Nasdaq 100 Index (Nasdaq: QQQQ)
Option / Symbol: Jan. 08 $40 put (WD MN)
Date Purchased: 11/27/06
Current Price: $1.15
Comment: Hold.
Company / Symbol: Nasdaq 100 Index (Nasdaq: QQQQ)
Option / Symbol: Jan. 08 $48 call (YWZ AV)
Date Purchased: 11/27/06
Current Price: $3.00
Comment: Hold.
Company / Symbol: Microsoft (Nasdaq: MSFT)
Option / Symbol: Jan. 08 $30 call (WMF AF)
Date Purchased: 8/8/05
Current Price: $3.78
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $12.66
Comment: Hold.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $35 call (WZY AG)
Date Purchased: 4/25/06
Current Price: $1.55
Comment: Hold.
Company / Symbol: Advance Micro Devices (NYSE: AMD)
Option / Symbol: January 2009 $35 call (VVV AG)
Date Purchased: 6/21/06
Current Price: $1.25
Comment: Hold.
Bull & Bear Spreads
Company / Symbol: Allstate (NYSE: ALL)
Option / Symbol: Jan. 08 $60 put (WLZ ML)
Date Purchased: 12/8/06
Current Price: $2.00
Comment: Hold
Company / Symbol: Allstate (NYSE: ALL)
Option / Symbol: Jan. 08 $55 put (WLZ MK)
Date Purchased: 12/8/06
Current Price: $0.95
Comment: Hold. Sold put against Jan. 08 $60 position.
Company / Symbol: CBOE Volatility Index (WCB: ^VIX)
Option / Symbol: Feb. 07 $15.00 call (VIX BC)
Date Purchased: 5/3/06
Current Price: $0.45
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: $0.35
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: $5.20
Comment: Hold.
Company / Symbol: GoldCorp (NYSE: GG)
Option / Symbol: Jan. 09 $40 call (OPJ AH)
Date Purchased: 6/9/06
Current Price: $2.85
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: $1.20
Comment: Hold.
Company / Symbol: Teva Pharmaceutical (Nasdaq: TEVA)
Option / Symbol: Jan. 08 $45 call (WTX AI)
Date Purchased: 5/23/06
Current Price: $0.45
Comment: Hold. Sold call against January 08 $40 position.
Company / Symbol: Energy Select Sector SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (XLE 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 (XLE MK)
Date Sold: 3/30/05
Current Price: $0.10
Comment: Hold. Sold put against January 07 $39 position.
