Natural Gas: Now Oversold

PLAY: Buy the UNG January 40 Calls (UNG AN) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).

Dear Bottarelli Research Member,

Today’s newest LEAPS pick comes with a simple premise…

Natural gas has now gotten over-sold, and we will see a bounce between now and the end of the 2008 calendar year. To play this bounce, the best (and safest) way is using the United States Natural Gas Fund (UNG – AMEX).

Truth be told, most investors are not even aware that the UNG exists. But by investing and managing NYNEX natural gas futures contracts, the UNG is a non-diversified fund that replicates the performance of natural gas. As a result, it offers you the ability to profit off the movements of natural gas prices without having to trade complex futures contracts.

From a technical aspect, the recent performance of UNG is quite remarkable…

In the seven months from January of 2008 to July of 2008, UNG gained 77%, moving from $35.00 into the high $60.00 range. But since hitting those highs in July, the index has since gone into a parabolic decline.

In just over one month, UNG has essentially erased all the gains that it took seven full months to acquire. And as it stands today, the UNG has retraced almost 100% of its prior upside move, which is quite a substantial sell-off over a four-week period. Therefore, I feel that the UNG is now trading very close to its near-term bottom.

A standard recovery could take the UNG back up to its 200-day moving average under $47.50, perhaps settling in between the mid-point of the 50-day and 200-day moving averages around $50.00. Support of this recovery move can be found by comparing the recent declines of natural gas and oil prices.

You see, while the mainstream media has given a tremendous amount of exposure to oil’s price declines in the month of July, what has gone unnoticed is the fact that the declines in natural gas have been twice as severe.

Since hitting a high in early July, for example, natural gas prices have declined by 33% while oil prices have declined by 16%. This pricing skew is rather interesting, especially when you compare the oil versus natural gas pricing relationship going back to 1990.

Over an 28-year period, the average price ratio between oil and natural gas has been 9.2. That’s 33% below current levels, implying that oil has more downside or the sell-off in natural gas has been way overdone. Either way, adding calls on UNG anywhere under the $40.00 level looks to be a strong entry price, especially leading into the autumn and winter months. Therefore, let’s play any forthcoming up-ticks using January calls.

PLAY: Buy the UNG January 40 Calls (UNG AN) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).

UPDATES

TACTICAL NOTE: The recent declines in oil prices, as I mentioned above, have triggered severe selling pressure across the entire commodity sector. As a result, these declines have resulted in downside moves in some of our current LEAPS positions. Now, since commodity bull markets can easily run as long as 10 years, buying into these 2-month price dips makes sense for longer-term investors. But when it comes to our LEAPS plays, even an extended time horizon (like January of 2009, for example) may not be enough time to ride out the current selling pressure. Therefore, in response to the current market conditions, we must adhere to our pre-set stop prices and reduce our commodity exposure by closing some of our current positions. Specific notes on such positions are found below.

JASO January 15 Calls (QJP AC): JASO has held strong at the $14.00 bottom, as I indicated that it would. The next hurdle would be breaking through the $16.00 level, which could offer the momentum to ignite a run to $18.00 and $20.00 by the end of 2008. Hold.

Ultra Short Dow 30 Pro-Shares October 65 Calls (DXD JM): In the midst of a wild market week (where we experienced a 300-point upside move, a 230-point downside move, and another 200-point upside move) I continue to feel that the threat of a substantial sell-off could be coming soon. Therefore, maintain your protective ultra-short calls for downside protection, and be sure to lock in the remainder of your profits on any forthcoming market sell-offs. Hold.

Valero Energy January 35 Calls (VLO AG): VLO continues to present a strong recovery play, especially as oil prices keep moving lower. Hold.

Deckers Outdoor September 90 Puts (QUK UR) & Salesforce.com November 55 Puts (CRM WK): These two companies continue to represent the most overvalued stocks that I can find, so maintain your downside puts for pending breakdowns. Hold.

Foster Wheeler November 75 Calls (UFB KO), Companhia Vale do Rio Doce January 37.5 Calls (VOH AU), & Weatherford International January 2009 50 Calls (WFT AJ): Here are the three LEAPS positions that must unfortunately be closed off. All three have traded down and reached our stop loss prices, but I have stubbornly held onto them for a pending recovery. After all, the expiration dates between November and January offered us plenty of time. But despite any momentary upside ticks (like the $6.00 upside move on FWLT, for example), all three LEAPS calls continue to deteriorate in value. Therefore, I will adjust my strategy on these plays. Now make no mistake: My original thesis on all three picks remains solidly in tact. That is, FWLT, RIO, and WFT each represent three of the strongest companies positioned in profitable and powerful sectors, but they simply cannot extend upon any upside momentum in this current market environment. Therefore, we will temporarily close off all three plays now, and then look to re-enter into a January 2010 LEAPS play on any further share price weakness. This new strategy will accomplish two things. First, it’ll allow these stocks to continue moving down to phenomenal valuations. And second, it’ll allow us to buy an additional year’s worth of expiration time for reduced levels. In the end, I truly believe that all three plays will mount strong recoveries, and when they do, we’ll more than make up for our losses by adopting this new strategy. But until the timing is right, we must close off all three plays now. Sell.

Hovnanian Enterprises January 2010 12.50 Calls (YZX AV): On a more positive note, let’s go ahead and take profits on our HOV calls. Prices have hovered around the $1.85 level, good for a 27% gain from our $1.45 entry price. Let’s go ahead and lock in these gains. Sell.

CBOE Volatility Index October 25 Calls (VIX JE): The series of 200- and 300-point upside and downside days continues to support holding these VIX calls, as any substantial downside moves will quickly push them higher. Hold.

Overseas Shipholding Group January 95 Calls (OSG AS) & Entergy January 140 Calls (ODF AH): I have decided to continue holding each of these plays, simply because they each have the ability to recovery rather quickly. While they are below our entry prices, each of them can bounce back up and settle in between their 50-day and 200-day moving averages. Therefore, let’s continue to hold. Hold.

America Movil January 2009 70 Calls (AMX AN) & Petroleo Brasileiro January 90 Calls (PMJ AR): And finally, with both of these positions trading at such cheap levels, there really is no sense closing them out now. Therefore, let’s maintain each position and hope to see a strong recovery leading into January. Hold.

Sincerely,