Options Trader: Friday Outlook

Well this week went by quickly!

As I mentioned in last night’s wrap-up, it’s been a very low volume week and, on the whole, it’s been nothing to get excited about.  We need to make some serious break-outs on our Big Chart levels and I don’t think that’s going to happen with oil getting it’s usual boost into the weekend, especially with Rent-A-Rebel now pre-announcing their plans. 

The latest oil terrorist to run up the markets is CNBC’s own beloved Jim Cramer, who took time out of his busy schedule last night to devote 15 minutes of his show to misinform his viewers about oil.  If you have any doubt as to how important this message is to Criminal Narrators Boosting Crude, just log onto www.cnbc.com and look at where this segment is featured.

Cramer interviewed the CEO of Joy Global (JOYG), who supplies mining equipment, and somehow Cramer managed to twist a legitimate, healthy demand for minerals, into proving his point about oil.  Cramer’s premise, that demand automatically means short supply is flawed on many levels.  If I have a mining company and you are paying me $86 a ton, I may run my mine normally (as it’s only $20 more than last year) but, if one month later, you offer to pay me $104 per ton, I may order a little more mining equipment to cash in while I can. 

Yes, there is a lot of demand for minerals and there are spot shortages, but they are due to delivery inefficiencies, not lack of availability.  It is called a demand CYCLE for a reason and sometimes the demand outstrips the supply but, in a free market, higher prices put more supply on line until you get to a point of equilibrium.  Speculators ruin the curve by creating false demand for product they do not intend to purchase causing miners to overproduce and commit to contracts with equipment makers like JOYG (a big Cramer pick) which eventually leads to a massive oversupply and crashes the market.  Don’t worry though, Cramer and his pals will be long gone by then - off to put you into the next thing they are looking to get out of.

Cramer says (at the 2:00 minute mark) "The gap in coal could be 60 to 100 million tons this year, that’s massive, even the US… can’t make up that amount."  While this may be partially true, the US does actually produce an average of 1,400M tons of coal per year and has certainly shown the ability to produce over 120M tons a month on a regular basis so it is no stretch to imagine that the US ALONE COULD make an extra 60 (4.2%) and perhaps 100M tons (7.1%) over the course of the year if the demand were truly there.  On a global scale of course, 60-100M tons is a rounding error.  Con men like to use big numbers to confuse people who don’t take the time to do the math and Cramer is a confessed master manipulator but this is a new low, even for him!

There are 998Bn tons of coal in the world and even this extensive IEA report shows there is no danger whatsover of a shortage through 2030.  Of course there is more demand, because it’s cheaper than oil, but how can this be Cramer’s premise for oil going up?  Coal is a substitute for oil, every ton of oil shipped is another barrel of oil we don’t need - I know this is complicated so I’ll type it slowly for Mr. Cramer - They are both used for energy!

Cramer keeps using the term "endless demand," it is probably good to be suspicious of people who say things like that, it’s a lot like the guy who calls you on the phone with a "can’t miss" investment or the guy who wants you to give him money for the perpetual motion machine or products that grow hair.  It’s very hard to imagine that Cramer is actually ignorant of the fact that thousands of years of economic history are firmly against him.  The only thing that IS different this time is the runaway speculation that has been made possible by a combination of Wall Street pushing all forms of commodity investing along with a relaxing of regulation that allows rampant speculation in everything from cooking oil to copper.

When there was a housing bubble, there were plenty of speculators and Caterpillar (CAT) was a booming business as were building supply companies, Home Depot (HD) etc., and Cramer was right there telling his sheep to BUYBUYBUY and all those stocks did rise to incredible highs in a speculative frenzy while Cramer’s pals at Goldman Sachs (GS) quietly turned around and shorted the market, making $6.5Bn betting against them whole gracefully dumping their long positions on Cramer’s legion of bag holders.  Now, 2 years later, Cramer is herding the sheep into Bubble 2.0 and it seems that sheep have very short memories but you would think they would at least notice all the for sale signs on the homes they drive past as they drive to their broker to blow some cash into the commodity bubble…

Anyway, I just want to say my piece now so that maybe, when Cramer is herding people into Bubble 3.0, 24 months from now, I will be able to point back to this article as a warning and save people a few bucks.  Meanwhile the CTFC is breathing down the necks of Jim’s speculating buddies, perhaps causing the urgency of his latest pump as US regulators "disclosed a broad nationwide probe into potential oil-market manipulation and said they are expanding surveillance of energy markets."

According to the WSJ:

• The CFTC’s announcement about its oil investigation suggested a single, broad probe that began in December 2007. But people familiar with its enforcement priorities say the agency is pursuing multiple oil investigations, and that many of them relate to one another. CFTC enforcement chief Gregory Mocek said the agency has about 60 manipulation investigations open in various commodity markets.
• The CFTC has expanded an investigation, disclosed previously by The Wall Street Journal, into alleged short-term manipulation of crude-oil prices via a widely used price-reporting system run by Platts, a unit of McGraw-Hill Cos. One suspicion is that energy companies and traders have at times issued a flood of orders during a time window used by Platts to determine its reported prices for physical oil transactions, then used the potentially distorted prices to make profits in other markets.
• Another area of concern for CFTC regulators is whether the owners of crude-oil storage tanks use their knowledge to make bets on oil-futures markets. In theory, the owner of a tank could issue misleading information about the tanks being full or empty, leaving the wrong impression about whether oil is in plentiful supply. Then they could make trades to profit on the misunderstanding.
• Large speculators such as hedge funds often use unregulated over-the-counter platforms, whose prices may affect prices on regulated markets. Mr. Chilton, the CFTC commissioner, said regulators are looking at cases where traders have made simultaneous bets on unregulated and regulated markets, in particular in West Texas Intermediate crude-oil contracts.

These are very serious accusations and, more importantly, serious indications that the government is finally getting serious about reining in the madness of the commodity markets.  If this happens quickly, many commodities, but especially oil, could collapse like a house of cards as investors who thought they would have many months to unwind their positions suddenly find themselves losing 5-10% a week.

Asian markets were good this morning with the Nikkei popping 214 points but, as we noted in the Big Chart, they had a lot of ground to make up and the finish at 14,338 is still well below the 20% mark (off the 2007 highs) at 14,640.  The Hang Seng picked up 0.6% but has also lost a lot of ground over the past two weeks so it remains to be seen whether Asia is truly recovering.  India’s economy posted better than expected growth (8%) but that makes it MORE likely that the Central Bank will tighten monetary policy.  Japan’s economy went the other way with continuing declines in housing and industrial production.  Consumer spending was also off sharply and April jobs numbers weakened.

Europe is up about half a point. UBS (UBS)  is under investigation for helping wealthy clients dodge taxes, this could widen to other financials as it seems like it was rampant over there.  UK’s Silverjet airlines ceased operations in another round of long-term demand destruction as those planes will use zero fuel next year.  Beware of the moves in Europe and Asia as they were generally based on declining crude prices and we know not to buy into those until we see it stick for more than a few days!

We had great earnings from Dell (DELL) last night and that should give us an early boost to the Nasdaq in the very least.  Solar stocks are rallying as Germany cuts subsidies less than expected, including our pals at First Solar (FSLR) and we couldn’t be happier as our last move on them was to take out our callers and roll ourselves down to the $280 calls.  At this point, I don’t think things could possibly go better on that play and we may have to shut it down!  Cypress Semiconductor (CY) will lag the solars and the $28s at .85 will make a nice momentum play if the market stays strong.

Consumer spending and income were up 0.2% but that is barely keeping pace with inflation so I don’t think much of the pre-market rally caused by those numbers.  Any positive close would be great today, especially on the Transports (2,714 is our goal), the Nasdaq (2,513) and the Russell (745).  It is probably too much to hope for the S&P to take back 1,425 but 1,405 would make key long-term support levels so that will be something we need to keep an eye on all day.

We were short on Google (GOOG) yesterday, expecting a top at $588 followed by a pullback to $575 and we’ll have to watch this carefully.  Most likely we’ll roll up first and then put tight stops on the position, giving up if it breaks $590 but, otherwise, let’s stick with the plan.  It is the last day of the month so all sorts of crazy things can happen.

Have a great weekend.

Comments

[SChase:]

Phil,
I read your column often and you've been an oil bear for years now. I also agree that oil is most likely in a bubble stage. However, I wonder how much money you've lost going against the grain on oil, or, against any bubble for that matter? You are obviously a contrarian who despises hype, however, the worst thing you can do as a trader is to be on the wrong side of a bubble. My question to you is, how many shots have you taken on shorting oil? I would guess you've taken quite a few based on the tone and frequency. How have they worked out?

Schase

2008 May 30 12:30 PM

[User 143167:]

My hench is : the oil bubble won't pop until Phil capitulates.

2008 May 30 12:44 PM

[Philip Davis:]

Schase - You have to understand options trading to understand how we play a bubble like oil. It goes up in spurts and comes back down and the strategy we pursue shorting oil stocks is we pick a top and (for example) buy the XOM $90 puts on the 16th with $2K out of $10K allocated at $1.50 per contract (13 contracts). When the position moves 30% against us, which it did just 2 days later, we buy 13 more for $1 ($3,300 invested on 26 contracts).

Since it spiked up to $95.70 on the 21st and we thought it was toppy, we rolled those contracts to the $95 puts for + $1.50 per contract, effectively another double down. That put us in 26 XOM $95 puts for $3,300 + $3,900 = $7,200. Since we rolled to a higher strike we increased our allocation but the next roll (if XOM broke $97.50) would have been to move to July puts ($95s for + $1.20) and sell some June puts ($90s for $1.25) to pay for it.

In this particular case, there was no need as the stock came flying down and made us a nice double, which we got out of yesterday and flipped long to play the bounce back, hoping for another nice run up to short into.

We do this all the time and we play both sides but we very much think the whole thing is a scam so it's easier for us to commit the big money to the downside when a stock runs too high. We have 700 members and that's the kind of trading we teach at PSW. There are oil bulls and bears there and we all get along very well because when one group gets out, it's a great signal for the other group to get back in. As User 14.. says, someone else's captitulation is always a good sign to get in yourself and we have a really good community that helps each other trade.

With options using a good cash management strategy, you can ride a bubble like oil up and up and up and still make a really good return when it slides. We are not long-term holders and generally we allow for a stock to run against us for 3 full months but after 45 days we are generally just trying to get even after flipping to a spread.

Obviously, not too many stocks run straight up for 3 months so we have a pretty high success rate.

2008 May 30 04:34 PM

[Mike P:]

Watching CNBC for market insight is like watching "Live with Regis and Kelly" for world news; so why even bother when Bloomberg is so much better?

2008 May 30 04:45 PM

[Commodity B...:]

Yesterdays fast money is a PERFECT example of CNBC's lack of a balance.

When they decide to actually discuss speculation in the oil market, they brought in Hirsch of the Hirsch report in 2005 that warned of impending peak oil. With all due respect to him, if you look up his bio (former Exxon Mobil guy, now with "Management Information Services", a company that doesn't have any profile whatsoever) you'll realize that he's part of "Dick Cheney oil fraternity", which also happens to include our good friend Matt Simmons (who's wonderful investment bank has never represented an oil major in any transaction in it's 3 decades of existence), Boone Pickens (who was such a shitty oil man that he decided to start his own hedge fund), and the other "Peak oil prognosticators". This clearly detracts from the discussion about what is really going on in the oil market and how the hedge funds are operating (and they never talk about this ever).

Matt "There's no speculation in the oil market" Simmons clearly demonstrates with the following article that he is a complete hypocrite who's opinion should not be trusted.

www.simmonsco-intl.com...

Here's the cliff notes version:

In the late 1990s, the price of oil was tanking with ample supply. Matt Simmons, in his ultimate wisdom, argued that speculators basically were artifically pushing down the price of oil and were more important as price determinants than fundamentals b/c of their large sums of money.

Fast forward to today, there's now ALOT more money from hedge funds, large investors, investment banks trading the physical oil and purchasing tanks to manipulate supply/demand data for futures trading, and at least two new deregulated dark trading platforms in the oil market, but in Mr. Simmons mind there is less speculation now than there was in 1998? I guess he's totally missed the boat on the following energy trading scandals in the last 5 years (and these are the ones we know about:

Enron
El Paso
Amaranth
BP's cornering of the propane market
Two other hedge funds getting busted for manipulating the gasoline market

And while this one wasn't illegal:

Goldman Sachs' rebalancing of it's Commodity Index that tanked the price of gasoline overnight.

2008 May 30 06:30 PM

[tom1234:]

cramer ---cramer --cramer---he wants to help you make money ---anyone who does anything for nothing for my beenefit is 1) too expensive ---cheap is always too expensive in the long run for me -2) when one works for nothing i look at them as amatures ( hense from the latin verb amo --amas --amat)---in philly they call his type a huckster--his program in my mind is off--off--off

2008 May 31 08:25 AM

[Allanmck:]

Tom1234, I couldn't agree with you more. I have always suspected that Jim is a better talker than analyst.

2008 May 31 03:16 PM

[Mike P:]

Here's an interesting article on oil & agri. contracts deregulation:

Who is responsible for the global food crisis?
SINCLAIR STEWART, PAUL WALDIE
Saturday, May 31, 2008

www.globeinvestor.com/.../

2008 Jun 01 03:37 PM

[pachanguero:]

Sorry but this dude has been beatin the same drum for over a year. You are wrong at 100 and still wrong today

2008 Jun 03 08:36 AM