Portfolio Updates: Diamond Offshore and NEW

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February 8, 2007 | SIN Picks | | Author Asif

After announcing a $4 per share special dividend in January, SINLetter pick Diamond Offshore Drilling (DO) announced fourth quarter 2006 results today that totally blew away analyst estimates. The company reported earnings of $1.60 per share, well above analyst estimates of $1.37 per share and more than double what it earned in the same quarter last year. Fourth quarter revenue jumped 57% to $578.2 million from $368.32 million last year. Full year 2006 results were even more impressive with earnings rising 171.5% to $706.8 million and revenue increasing 68% to $2.05 billion.

As mentioned in the February 2007 edition of SINLetter, deep water drilling remains profitable if the price of crude oil stays above $30 per barrel. With the price of crude oil close to $60 a barrel, increasing utilization rates for its rigs and a huge deep water oil discovery last year, I see additional upside potential for this company that trades at a forward P/E of 9.86. The stock appreciated more than 3.6% in response to fourth quarter earnings and is now registering a gain of about 14% in the SINLetter model portfolio.

It is amazing what a difference a week can make. The very put options that hurt our portfolio in January have now helped propel it to new heights. As I write this blog entry, the portfolio is registering gains of over 92% (the portfolio automatically updates itself periodically during market hours) thanks to an astounding gain of 305.56% in our May 2007 $35 put options on the sub-prime mortgage lender New Century Financial (NEW). The stock of New Century lost almost a third of its value today after announcing that it expects 2007 loan production to be 20% below 2006 levels. Since the weakness in the housing market is expected to continue at least until mid-2007, I am not surprised to see the mortgage lenders head lower and that was the reason I picked up put options on New Century Financial (NEW), Countrywide Financial (CFC) and the homebuilder St Joe (JOE). St Joe is no longer in the home building business and has become more of a play on the vast tracts of land it holds in Florida.

It is quite clear that the housing boom is over and both homebuilders as well as mortgage lenders have seen a drop in the share prices but for some reason the stock of Countrywide Financial remains untouched in spite of its large portfolio of ARM loans and heavy insider selling. To illustrate my point, check out this one year chart of NEW, LEND and CFC. There have been many buyout rumors surrounding Countrywide (especially right before their last earnings announcement) but they have been denied over and over again.

Portfolio Adjustment: I am going to take some profits off the table by selling 3 out of the 5 put option contracts on NEW (NEWQG.X) using the last trade of the day as the selling price and will also be selling our March 2007 put options on the Dow Jones Transportation Index (IYTOQ.X) and taking a loss.

Note: As mentioned in the newsletters, naked options are highly risky financial instruments with the possibility of losing your entire investment. I could also be spectacularly wrong about these options. Hence the initial position sizes of options in the SINLetter model portfolio are relatively small ($2,000) when compared to the initial position sizes of stocks ($6,000 to $10,000) in the portfolio. Put options are primarily used as a hedge against our long portfolio.

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