Options Trader: Weekly Wrapup

by: Philip Davis

How did I end up so bullish?

One great thing about writing a daily column like this is it forces me to be introspective, and I highly recommend taking time to review your thinking once in a while; learning to be critical of your own thought process can stop you from making all sorts of mistakes and learning to trust yourself can help you to make all sorts of money!


On 2/20, when the market was at its dead top and our pals at the WSJ headlined : "The markets are moving into a sweet spot" and that "the mood is downright bullish." This caused me to say:

While I’d love to go gung-ho bullish here, we are at an inflection point and we need to break out right here, right now to make a real rally of it. We’ll be looking to pick up our weekend plays but this is no time to be rushing into anything until we get some better signals. Be very careful out there!

Just 14 days later, on March 6th, the Dow had dropped 700 points and I was in a very contrarian mood, saying:

I’m not a contrarian by nature but I am usually ahead of the curve, when the curve catches up to us it’s often time to change trains (that sentence is sponsored by Metaphor Mixers, Inc.). So today I’m feeling much better about my bullish sentiment as only 29% of the bloggers polled agree with me. That’s my comfort zone!

Then those pesky Iranians took British hostages and derailed our nice recovery, but not for long and when you see the market recovering from blow after blow after blow, it’s a little silly not to be bullish, isn’t it? Now to be clear, I’m bullish and mainly in cash as we relentlessly took positions off the table during March, but that allowed us to take advantage of some opportunities last week and gave us plenty of dry powder to initiate a new round of oil puts. While I have been happy to go with the flow in the markets, perhaps I am getting to be too much of a perma-bear on oil… On 3/25 I said:

Ahead of Wednesday’s oil inventories I said 'I still have my COP covers if it’s bullish and I guess I would go with XOM $72.50s or HAL $30s on upward mo' and, despite a fairly bearish report, the pump crew swung immediately into action and brought oil up to $62 for the week. I wasn’t buying it and killed my COPs for $2.80, a BIG MISTAKE for the week.


It may have been a BIG MISTAKE but it’s one I made again this week, which is why I wrote my recent oil post. While it may be a scam (I KNOW it’s a scam), it does happen to be the largest, best organized scam in the history of mankind and when the Wall Street Journal is a willing participant in pumping up the price of oil, we really do have to throw in the towel on shorting. The only problem with learning to love high oil prices is I don’t know if the economy can really stand it. My bullish economic premise is, in large part, based on the fact that I consider commodities to be in a bubble that may not pop, but at least should soft land to some level like oil at $50, copper at $200, gold at $450 - high, but livable.

Click to Enlarge
List of Oil Trading Nations

Can the American people, who consume 21Mb of crude a day, afford to pay $20 per barrel more, sending an EXTRA $220M a day overseas to pay for energy, putting how many billions of dollars a year directly into the hands of nations like Iran and Venezuela, who have nothing but contempt for us? Remember that is just our share, OPEC supplies 41% of the world’s 85Mbd of crude so every dollar a barrel represents $12.7Bn a year in additional revenues for those 12 countries.

While $12Bn may not seem like a lot of money to our $13T economy, for our poorer neighbors in the Middle East, it means the difference between being able to buy a limited short-range chemical weapon or a nice nuclear ready Shahab-6.

Slippery Slopes

In fact, as you can see from the above chart, the burden of paying $60+ for oil falls very squarely on our (Western nations’) shoulders, which is why I have to laugh when people say we should keep politics out of the financial columns. Only an energy policy from hell can lead to the ridiculous situation this country has found itself in.

Only 30-plus years of neglect since the last two "oil crises" (there was on in 1973 AND 1979) can put us in an even worse situation today than we were in in 1979. Only the willing participation of certain (many) politicians and their corporate masters can put this country in a position where we now spend over $500Bn a year on oil - more than any five other countries combined!

Imagine how laughable the $5,000 per American family per year we spend on energy must seem to the average family in China that gets by on a total income of $2,000 annually. It has cost the oil industry just $500M since 1998 to "convince" our government to do nothing as U.S. energy expenditures rose from $100Bn (1998), to $200Bn (2001), to $300Bn (2003) and on to our present half a trillion dollar total. While the $300 per person in "excess" taxes the government was collecting was considered a "crisis" in the 2000 election, the $1,000 per person increase in annual energy spending seems to be just fine.


As much fun as it is to ignore the situation of laugh it off, it has very real consequences for the U.S. economy as a whole and that does affect our stocks. Total corporate profits in 2006 are "just" $1.5T on $18T in revenues but that includes profits of $100Bn in the energy industry alone, up 150% from 1998. If you are going to turn into a one-horse economy, this may not be the best horse to hitch our wagon to!

That, in a nutshell, is my overriding concern with the economy - how do we, and the world, sustain this level of growth, while paying these energy prices, without triggering an inflation cycle that could quickly spin out of control?

So I continue to invest with a lot of covering positions, but with a mid-term bullish posture, as this is the sort of thing that can be (and has been) ignored right up until the time that it blows up in your face. As long as we keep taking our profits with some degree of cynicism and avoid "reinvesting" all of our profits into additional risky positions, we should be able to make a bit of money and take most of our principal off the table when the time is right. Aside from making accurate predictions of a correction on March 20th, I also made a similar call ahead of our mini correction on Thanksgiving and I called the May 2006 correction on the button saying (on the morning of May 10th): "If the Nasdaq does not go up today I will be moving into an almost all cash position as it is likely to take the other indices down with the ship, so let’s be careful out there!"

Conservative Sun Ray Treatment

Again, we review to see where our thinking was wrong, but also to give us confidence to go forward. I do know a top when I see one and I need to perhaps worry a little less about getting caught in a crash and a little more about going with the flow and partying like it’s 1929.

Going with the flow led to a nice recovery last week, when we posted 56% cash gains on our closed positions but this week we had to exit some unfortunate oil puts and buy back several calls we had sold against longer positions as the market ran up on us. This held us down to a 28% average gain on 28 positions closed with a cash gain of just 35%. It doesn’t sound so bad, but as I said last week, it leaves us a lot of dregs and our 92 remaining short-term positions are still netting about even and dangerously bullish (62:30 with most of the puts being on oil). Due to existing losses on the oil positions, from a cash perspective the Short-Term portfolio is now 3:1 bullish.

As I said before, how did I get so bullish?

Last Friday I was still in a bad mood and I said:

Keep in mind that this is the EOQ so we really don’t care what they do today so it’s a good day to start drinking early." Monday got us quickly out of the doldrums with over $120Bn worth of mergers announced that morning and I decided that, although I was sickened by the unfettered corporate greed that was turning the world into a giant game of Monopoly, that it was time "to assess the situation and go out there and make some money!

During the day on Monday, Bill Poole found it necessary to explain that the Fed wasn’t joking and were still worried about inflation and Friday’s jobs numbers put the nail in the softening coffin for this quarter at least.

On Tuesday, as I’ve been saying for two weeks, I said we would get a true(r) read on the markets, and we certainly got a good one as our new tracking system went from this:

Chart #1

To this:

Chart #2

Quite an improvement! Obviously, we’re going to need a bigger chart, but even the transports are starting to come around. So if we can just get oil to get back under $62.50, everything should be hunky dory for our journey to a full retest of February’s highs.

We were on top of the move Tuesday morning when I said:

A good pre-market move is to set 20% (of profit) stops on the calls we sold against our LTP plays, no reason to give that back and we can always resell them!" Unfortunately on Tuesday, it only took until 10:54 for me to worry about our oil puts when I said: "Sharp VLO reversal underway! I’ll be very concerned at $64.25." Just a little later at 11:30, we had to get out of our old puts: "Damn, VLO broke up - CNBC is pumping the hurricane non-stop now with graphics and hurricane footage all over the place. If oil gets back over $64.50 we have to give up on these puts (VLO also has a goal of $64.50).

That’s exactly what happened.

We would have had a much better week if we had gone with that flow as the group gained about 2% since Valero Energy Corp. (NYSE:VLO) broke $64.50 on Tuesday and we will go back to following the Rule and not trying to outsmart ourselves too much, as there’s lots of money to be made on both sides of the volatile energy market.

Also exactly what happened were my calls for a DD on our positions in
FedEx Corp. (NYSE:FDX), Microsoft (NASDAQ:MSFT), Texas Instruments Incorporated (NYSE:TXN),
MEMC Electronic Materials, Inc. (WFR), Dell (NASDAQ:DELL), YRC Worldwide Inc. (NASDAQ:YRCW), Intel (NASDAQ:INTC), IntercontinentalExchange, Inc. (NYSE:ICE), Marvell Technology Group Ltd. (NASDAQ:MRVL),
American Express Company (NYSE:AXP) (with AXP and YRCW still lagging). Additionally, my new positions on Google (NASDAQ:GOOG) (which gapped up fast but were good calls) made up for the underperformance of the oil puts. I notice many people still don’t use the oil puts for what they are meant for - as a hedge against a collapsing economy and as a balance against calls, this is still something we all need to work on.

I made that mistake myself with the $10K Portfolio, taking riskier than necessary oil puts as I became impatient with the returns. This has put us back to square one as the $1,324 of unrealized losses [almost all from VLO and Tesoro (NYSE:TSO)] have virtually wiped out the $1,715 cash gains to date. Those of you who know me know I am not at all satisfied with a $380-dollar, three-week return but we still have $4,900 in cash to deploy so let’s make sure we find a way to turn it around in week four!

On Wednesday we got our oil build (5Mb) but the 5Mb gasoline drawdown and the pending holiday weekend kept prices high to close the week. This leaves the NYMEX with the largest barrel overhang I have seen since I’ve been tracking it (540Mb in the two front months) and I will be truly fascinated to see how they pull this off. Notice, however, I am now coming around to the view that they CAN continue to perpetrate this fraud indefinitely. Our final barrel count for the week is 340M May, 200M June, 83M July with a 2007 total of 901Mb, a monthly average of 113M, 80M barrels more than actually get delivered in a single month.

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Larry\'s a Billionaire

On Wednesday morning our pal Ahmadinejad decided to release the British hostages and it did seem that the markets were happy about it. We got my SOX rally and the Fed continued to feed the market fires with a flood of "easy" money to the prime brokers, another action I object to (as it takes tax money and gives asset breaks to the wealthy). The only solution to this unrelenting preferential treatment of the top 1% of income earners in this country is to make sure we join them and just try to avoid having our backs pressed against the walls when the revolution comes.

On Thursday I cautioned that now we have to worry about the new GasPEC that is forming in Doha next week’s Federated Unified World conference called by Russia, Iran, Venezuela, Libya and several other of our favorite White House dinner guests. Nonetheless I said we should expect continued healthy consolidation and that’s what we got. As I said in the morning: "It’s a very chintzy way to have a rally but we’ll take it!"

I’m thrilled to stop worrying and love the rally if the Fed is able to convince me they are pursuing my inflation agenda (details in Thursday’s post) but it’s a very dangerous game to play but one that needs to be played by a country that has backed themselves into a very tight corner. Jobs numbers were a big beat on Friday with unemployment almost back to the lows we came to expect during the Clinton years but with far less productivity gains than we enjoyed in the 90s. "Unit labor costs are not decelerating and productivity is not trending higher, despite the Fed’s comments to the contrary," said Drew Matus, economist at Lehman Brothers. "The dark cloud is the inflation story, and it’s not going away."

It looks like we may have to wait a while for that glorious day when we are all replaced by machines as the bulk of the gains came in the service sector along with a migration of construction workers from single family homes to commercial construction, which is a very good thing if the demand is really there!

As usual, the star of our show was the Long-Term portfolio, which ended the week with a net gain of $25k (7%) despite some very painful buyouts of short calls that we had sold and were turning against us. The portfolio now has a crazy average gain of 165% on just 44 open positions but that is mis-weighted by a 3,260% gain in Cell Genesys, Inc. (CEGE) and a 978% gain on one of our iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI) positions. The more reliable net gain on capital is at 64%, up a point from last week. Our new balance is $380K on $231K invested and we are now weighted as bullishly as we have ever been in this portfolio with just 10 of 32 leaps covered and one of those covers being on one of our only three puts. Expect some shifts in the LTP this week, especially as we still have nine leaps in the STP (none of them puts either!).

Our stock positions are averaging a 12% gain on 56 average days open and we stopped out of our NVR, Inc. (NYSE:NVR) shorts this week, something I’m very glad of with the new construction numbers. Since no one ever asks me about the stock positions, I assume no one cares - please correct me if I’m wrong…

This week was dead dull compared to last weeks fast and furious moves. Mainly we shifted to a more bullish posture whereas last week we took full advantage of the market chaos which had caught us flat-footed the week before. Here’s the rundown:







AMZN A  $  38 C 3/16 -10 $1.65  $  3.60 4/3  $    1.95 118%
CHK A  $  30 P 3/29 40 $0.25  $  0.10 4/3  $   (0.15) -60%
CSTR A  $  30 C 2/20 12 $0.95  $  1.50 4/5  $    0.55 58%
CVX A  $  75 P 4/3 10 $1.20  $  1.10 4/3  $   (0.10) -8%
DIA A  $ 122 P 3/13 50 $1.75  $  0.90 4/2  $   (0.85) -49%
DIA A  $ 122 P 3/30 50 $1.00  $  0.90 4/2  $   (0.10) -10%
GOOG A  $ 470 C 3/28 -40  $11.25  $ 11.00 4/3  $   (0.25) 2%
ICE A  $ 125 C 4/4 5 $3.00  $  3.95 4/5  $    0.95 32%
ICE A  $ 125 C 4/2 10 $2.30  $  3.30 4/2  $    1.00 43%
IGW A  $  60 P 3/13 50 $1.10  $  0.75 4/2  $   (0.35) -32%
IWM A  $  78 P 3/30 50 $1.00  $  0.90 4/2  $   (0.10) -10%
IWM A  $  79 P 3/29 50 $1.30  $  1.20 4/2  $   (0.10) -8%
KO A  $  48 C 3/16 -10 $0.75  $  1.60 4/3  $    0.85 113%
LLY A  $  55 C 11/8 40 $0.35  $  1.00 4/5  $    0.65 186%
MRK A  $  45 C 4/2 75 $0.85  $  1.20 4/5  $    0.35 41%
MRO A  $  90 P 3/14 80 $0.75  $  0.15 4/3  $   (0.60) -80%
MSFT A  $  28 C 4/2 100 $0.55  $  0.98 4/4  $    0.43 78%
MT M  $  53 C 3/30 -10 $2.00  $  2.30 4/3  $    0.30 15%
SHLD A  $ 180 C 3/30 -20 $3.75  $  5.00 4/3  $    1.25 33%
SPY A  $ 141 P 3/29 200 $0.85  $  1.30 4/2  $    0.45 53%
TSO A  $ 100 P 3/30 50  $ 1.80  $  3.00 4/2  $    1.20 67%
TXN A  $  30 C 3/16 -20 $2.10  $  0.75 4/3  $   (1.35) 64%
UNH A  $  55 C 3/29 10 $0.60  $  0.85 4/2  $    0.25 42%
VLO A  $  65 P 3/30 50 $1.30  $  1.60 4/3  $    0.30 23%
WCI J  $  23 P 3/21 10 $1.50  $  2.35 4/2  $    0.85 57%
WFR A  $  60 C 4/3 20 $1.60  $  2.35 4/4  $    0.75 47%
WFR A  $  55 C 3/16 -10 $3.50  $  4.50 4/3  $    1.00 29%
XOM A  $  75 P 3/28 50  $ 1.00  $  0.60 4/3  $   (0.40) -40%
XTO A  $  55 P 3/28 10 $1.15  $  0.95 4/3  $   (0.20) -17%

If we get a powerful market move next week, we will be sitting pretty but if fear of inflation seizes the market, we need to throw down our mattresses and take our lumps. Of course, we will get earnings starting Tuesday with Alcoa (NYSE:AA) et al and, more than what they report, how the market reacts to what they report will tell the tale of April.

Have a great weekend,

- Phil