Options Trader: Thursday Morning Ideas

by: Philip Davis

This is a very tricky day for the markets.

I'm hoping yesterday's knee-jerk reaction to the housing slowdown is replaced today by "Fed is dead" speculation as there is virtually no way the Fed can contemplate raising rates with this key economic indicator in the toilet.

The R word will come back into play for a few days, which should be just the ticket to move oil under $70 but the reality is that we do indeed have a strong economy - just imagine what would happen if the $146Bn premium we are currently paying for oil ($20 per barrel x 20Mbd) could be spent on other, more economically productive things...

While Exxon may miss out on $3Bn a quarter in profits (don't worry, they will limp along at $7Bn a quarter) there will be 100 other companies, for example, that can add another 120M in revenues - each quarter! And that's just Exxon!

That's right, the economic health of the United States of America is being sucked dry by oil companies and foreign cartels and the President has not done a thing! Perhaps that is because the last President that told people to save some energy by putting on a sweater was quickly replaced by a cowboy actor and this president's father (former head of the CIA, close personal friend of the Saudi Royal Family)...

Do you remember when they hired an actor to tell Americans that we should stop all this silly conservation talk and focus on the "shining city on a hill?" Perhaps it was something we wanted at the time but, in retrospect, it was not what we needed. Despite Mick Jagger's (LSE grad) best advice, politicians are always trying to give us what we want, rather than what we need.

Al Gore said we needed a .50 per gallon gas tax back in 1993 so we could spend $150Bn a year on alternate energy research to avoid a potential crisis down the road. Republicans killed that bill faster than universal health care based on the logic that paying $1.50 a gallon for gas would destroy the economy. Gore pointed out that all we would have to do is improve gas mileage in cars by 25% and the net cost to American people would be negligable and oil companies spent more money to defeat Al Gore in 1990 than any other candidate in history!

In retrospect, spending $2 Trillion over the last 13 years to develop energy alternatives may not have been such a bad idea. The current administration's budget is at $771M a year...

Al also had this wacky idea that if we doubled the size of the SPR we would have enough oil in reserve to control price spikes and lessen the ability of speculators to control the markets. Bill Clinton used the SPR back in 2000 when oil spiked to $37 per barrel and just 30M barrels out of our reserve drove the price back below $30 in one month. (link)

Yeah and free health care would have really been terrible too - good thing we dodged that bullet! Outside of energy, health care is the single biggest drain on discretionary income.

So, no matter what you think you see the economy is in excellent shape, it is just that the flow of capital is going into commodities, which benefit a small set of large campaign contributors, rather than into things that actually improve our quality of life. Much like the Matrix, the goal of oil companies, big pharma and health care is to keep you just barely liquid enough to keep giving them money (10% more each year if possible). They do not want you to go to the Gap and buy jeans when you could buy an extra gallon of gas or pop a pill for a disease that didn't even exist 5 years ago.

In order for our economy to thrive, commodities must decline. With over $1 Trillion of profits at stake, expect a heck of a fight for your consumer dollars.

I've been working on my consolidation numbers and here is the range I will be looking for to confirm an uptrend:

* Dow: Support at 11,200 and resistance at 11,400.
* S&P: Support at 1,280 with a breakout at 1,330.
* NYSE: Support at 8,200 and resistance at 8,400.
* Nasdaq: Support at 2,100 with 200 dma breakout at 2,230.

Look for (hopefully) higher highs and lower lows to signal a breakout as we move forward. Bernanke speaks tomorrow and this thing could really go either way and I don't expect them to go any way until he's done. It is now more likely that we will get a downside test than go up from here but it will be a good thing if commodities lead the decline.

The dollar is in strong decline today as the European economy is stronger than expected and it seems very doubful the Fed can afford another rate hike.

This is not stopping oil from declining even further in the global marketplace but natural gas futures have been pumped back up over $7 ahead of inventories which may give us good entry points on ECA ($55 puts at $1.65) and CHK ($30 puts at .30). With inventories nearing capacity (3,400Bcf) a build over 50Bcf will put us on track for a forced October production pullback. Storage is already 14% ahead of the 5 year average as usage has quickly declined.

Had it not been for last year's hurricanes, natural gas inventories would already be more than full!

What you need to understand about natural gas is that we are currently capable of producing over 5.5Tcf per quarter, we just have nowhere to put it. Q1 of last year had a record 6.97Tcf of winter usage but that number dropped to 6.38 (down 10%) this year. Forward projections for usage assume a reversal of that trend towards increased demand, should we trend down 10% for the whole year we will have a surplus production of 1.6Tcf, over 1.2Tcf more than can be stored (hence the push for LNG, which adds tremendous storage capacity).

Oil will face light resistance at $71 on the downside and heavy resistance at $72.50 on the way up. Las week's action has demonstrated that people are willing to go to war to defend $70 so it will really be up to the will of the speculators to make or break the market. Iran is on hold at the moment as they are playing politics (something US traders did not give them proper credit for). This makes them look dangerously rational to the oil bulls.

Gold may get a boost from the drowning dollar but is more likely to follow oil down as oil is responsible for 60% of our current inflation.

Like yesterday, we need to balance the top-line market numbers with a look at what is really going on. If commodities are dragging down the markets, there may be some tremendous opportunities in transports and industrials so keep cash at the ready and let's go bargain hunting through our recent selections!

I'm still using the S&P 1,300 as my primary benchmark but let's hope for Nasdaq leadership over 2,150 and positive movement from Apple, GE and AXP.

Positive surprises outweighed negative surprises in the S&P by 4:1 and 300 of the firms INCREASED FY 2006 guidance. 275 firms also guided up for next year. Of the firms that guided down, 42 were consumer discretionary and 30 were in tech, also based on consumer projections. Should the consumer again not be quite dead (year 7 in a row) we may have a very surprising second half of the year!


You just can't kill that US consumer with Swatch reporting a 13% rise in sales led by luxury lines leading to a 23% increase in profits. It took 10 analysts to underestimate earnings by 15%.

Apple is setttling their lawsuit with Creative for $100M, about a week's worth of IPod sales but I still can't bring myself to buy it at this price. Expect me to say the same thing at $77 and $87 before the year is over...

At this point I am ready to take a 1/10 position on GE Oct $35s for .25. If this does not work I will take 2/10 on the Decembers followed by 4/10 on March but there will be a point where this company goes to $37!

IMAX was decimated by scandal! The stock is involved in earnings shenanigans and the CFO just resigned. I don't want to catch a falling knife but someone is going to buy them at this price! Perhaps after the shareholder lawsuits get out of the headlines...

BNI is #1 on my hit parade as rail traffic is up way more than anyone is projecting. Earnings are out on 10/24 so I like the Oct $70s for $1.50 as I expect some early upgrades ahead of the report.

CSX is also in the sweet spot with Jan $32.50s at $1.35 but for both of these rail picks, let's make sure CSX holds $29.50 for a get out/don't buy signal.

I am hoping XOM comes back up so I can short it again. Let's keep an eye out for a reentry on all of our oil puts but only if oil remains under $71.50 and strictly following the Valero Rule!!!!

BP knew by the way.

EBAY is getting killed again by last year's story (whenever I hear an old, detrimental story coming back, I take it as a buy signal) - that raising rates will drive sellers away. To where? Back to basic economics, sometimes you don't want to service all the people as cheaply as possible (attn. Wal-Mart shoppers), sometimes you want to maximize your profits from the amount of people you can reasonably handle. Ebay is making the mature decision here as more revenues no longer equal more growth at this stage. We will watch this for a buy opportunity.

Absolutely buy out the PD Sept $80 puts we sold for .65 if you didn't earlier this week at 25 (85% profit). I'm almost inclined to buy them myself at this level! The Jan $82.50 puts are steady at $5.60 (down .20) but we may get some real movement in the next week so I'm not selling more current puts against it just yet.

The SNE $45 puts are back to even at $1.30 and I will be getting out if Apple holds up.

This is what happens to oil companies that aren't manipulated by US traders.

I don't know if you can pull this off today but yesterday the HLX Oct $35 puts closed at $1.40 while you can sell the Sept $35 puts which closed at $1.55. If they are just going to give money away like that I suggest you take it!

I'll be watching GSF as an oil indicator. They are just below a death cross 50 dma of $52.50 and are trading 25% off their high. The direction they take will be very telling so add them to the Valero Group for now!

I'm also watching SII, who are sitting righ on the 50 dma this morning and should be heading down to test the 200 dma at $40.50 if oil is heading down.

Can SLB maintain a p/e more than double that of HAL. HAL is selling off in anticipation of a Democratic House launching an investigation into war profiteering (anyone want to bet on HAL's innocence?) but SLB looks ripe for a takedown as well. $62.50 puts are $1.05 and can go in the money on a wiggle.

MDR $50 puts are on my list if they fail to hold $50 again. Currently at $2.20, I'm hoping for a $1.50 entry.

VTS $50 puts for .40 are a nice gamble but definitely a gamble!

It's not optionable but BNHNA at $24.41 will be an interesting restaurant play as I don't see people giving up special meals just yet.

WSM is riding the crest of my Consolation Prize Theory only they don't believe it themselves. They blew analysts out of the water with .29 earnings (vs. .23 expected) but gave horrific guidance as Pottery Barn (lower end) is dragging them down. I'll buy them on a pullback as they may be surprised by next quarter themselves.