Playing An Oil Bottom

PLAY: Buy the USO January 2010 30 Calls (KWW AD) at market, good for the day. Place a protective stop limit at $2.85 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

Dear Bottarelli Research Member,

I really don’t have to explain to you the roller-coaster ride that oil prices have been on over the last six months. As impossible as it may seem, the price of crude has fallen from $147 per barrel to $40 per barrel in just over six months. Not long ago, analysts at Goldman Sacks were calling for $200 per barrel oil prices. Today, we’re hearing predictions of $25 per barrel. To me, it appears like nobody has the slightest clue what the “true” price of crude oil should be. And in many respects, this opens up a tremendous opportunity for investors like you and me.

You see, while the entire news-flow in the United States is saturated with bailout packages and trillion-dollar stimulus plans, a series of events are quietly taking place that could soon spark an upside price shock in oil.

First of all, OPEC could dramatically reduce their oil output by cutting production. Back in October, for example, OPEC announced a 1.5 million barrel-a-day reduction. To give you a barometer of what this means, consider that the U.S. consumes around 21 million barrels of oil per day. By cutting production by 1.5 million barrels per day, we’re now getting 7% less oil from OPEC. Amazingly, despite this announcement, crude oil prices kept falling! But if you look closely, this production cut might just be the beginning.

For example, Chakib Khelil (OPEC’s President) recently suggested that future production reductions could be a lot deeper than anyone expects. That’s why I feel that the oil markets could soon be in for an upside price shock. Adding fuel to the fire, when asked about the best way to stabilize downward oil prices, Mr. Khelil said that the best way to accomplish this was to “surprise them.” That’s why some OPEC members have hinted about cutting production by another 2 million barrels per day.

Not only that, but OPEC has also joined forces with other oil-producing countries (like Russia), who agree with the idea of pushing oil prices higher. In fact, Russia recently signed a cooperation memorandum with OPEC to support production cuts. At the same time, China has been taking advantage of reduced oil prices to stockpile their oil supply. Therefore, you have the major oil-producing countries cutting production while oil’s major users, like China, are buying up as much available supply as they can afford. In a situation like this, the simple economics of supply versus demand tell you that oil prices appear ready to move higher. That’s why we’re going to add LEAPS calls on the United States Oil (USO – PCX).

The USO reflects the performance of the spot price of West Texas Intermediate light sweet crude oil. To replicate this performance, the USO invests in futures contracts for petroleum-based products like light sweet crude oil, heating oil, gasoline, and natural gas. Therefore, any up-tick in oil prices will be reflected in a similar up-tick in shares of USO.

Now, as you can see from the chart, USO has taken a substantial beating lately, moving from $120 in July of 2008 down to current levels around $30.00. Based on the situation with OPEC, Russia, and China (explained above), I believe that the $30.00 level will be the floor for the USO. If this proves to be true, then you could easily see the USO move back up to $60.00 in short order.

As a result, let’s get positioned to capitalize on this upside move by adding USO January 2010 30 Calls (KWW AD). If the USO moves up to $60.00, these calls could triple in value. And that’s a conservative estimate! Therefore, let’s get positioned now.

PLAY: Buy the USO January 2010 30 Calls (KWW AD) at market, good for the day. Place a protective stop limit at $2.85 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

UPDATES

IAG September 5 Calls (IAG IA): I am very comfortable holding exposure to gold plays in this market, especially when you have a powerful chart like IAG’s. Hold.

DIA April 70 Puts (DIJ PR) & VIX May 60 Calls (VIX EN): If the major market averages decide to re-test their November lows, you’ll be very glad you’re holding these two protective positions. Hold.

CELG July 55 Calls (LQH GK), GERN January 2010 7.5 Calls (WNM AU), Teva Pharmaceuticals January 2010 45 Calls (WTX AI), & Cubist May 20 Calls (UTU ED): Our collection of healthcare-biotech plays continues to look strong. In a market like this, where virtually every company is reporting putrid earnings, there are very few pockets of strength. Biotech is certainly one of the strongest sector groups, and that’s why we’re overweight on this group. Hold.

Genentech March 80 Calls (DWN CP): Our decision to “roll” our DNA calls out into March looks like it was a good idea, as the stock has indeed bounced off the 200-day moving average as expected. Hold.

Yellow Roadway January 2011 2.5 Calls (VYX AZ): Our powerful recovery play continues to look good. I expect continued upside. Hold.

ETH February 15 Puts (ETH NC): We officially locked in a 39% gain on this position by selling on Monday, so congrats on your gains! Sold.

Salesforce.com May 25 Puts (CRM QE) & Verizon April 30 Puts (VZ PF): Both stocks have bounced back up to their 50-day moving averages, but this is where we should see the next level of resistance. Barron’s recently ran a positive article on Verizon, but I don’t buy into their logic. In a slowing economy, I do not feel that customers will expand their wireless, data, and video packages. In stark contrast, I feel consumers will cut these extraneous items out of their monthly budgets. Therefore, my bearish viewpoint remains in tact. Hold.

MCD June 55 Calls (MCD FK), ADM January 2010 20 Calls (WRA AD), & YUM January 2010 30 Calls (WRJ AF): We’re getting close to the time where it behooves us to add to these “recession-buster” positions. All three were strong at the beginning of the year, as investors flocked to companies that could continue to prosper during difficult economic times. But as the fear subsided (thanks, in part, to a new president taking office), these stocks have peeled off some of their recent gains. I feel this is a temporary event. Therefore, we’ll look to add to our positions when the timing is right. Until then, maintain all three plays. Hold.

Tesoro January 2011 5 Calls (ZGC AA): Like an unstoppable freight train, shares of TSO continue blasting higher. Be sure to lock in gains at the 100% level, which would be right around $15.00 on your calls. Take remaining profits at 100%.

AK Steel January 2010 15 Calls (YDF AC) & Southern Peru Copper January 2010 25 Calls (YPV AE): Both stocks are bouncing nicely off their 50-day moving average, which bodes well for our longer-term recovery thesis. Hold.

Sincerely,