Potential BP (NYSE:BP) option trades, bullish and bearish

Potential BP <span class= BP option trades, bullish and bearish " src="http://farm5.static.flickr.com/4010/4465503128_567101bc2f_m.jpg" alt="" width="240" height="192" />Roughly two-and-a-half months after the April 20 Deepwater Horizon disaster, BP plc BP may be pulling itself up by its proverbial bootstraps. From its April 20 peak to its June 28 low, the stock surrendered more than 55% of its value. But recent optimistic reports and an upgrade on Tuesday have lifted the shares back above the $30 level. Royal Bank of Scotland said Tuesday morning that it was adjusting its rating on the oil-and-gas giant to buy from hold, as it sees improving catalysts for the shares.

The investment bank said a pessimistic outlook on costs relating to the oil spill in the Gulf of Mexico should already be priced into the shares, discounting their value. The bank also noted that “Stopping the flow of oil will cap the physical volume of the spill, reduce the daily costs being incurred, cool the political temperature, and, if BP’s share price remains excessively depressed, it could trigger credible merger speculation.”

With criticism and speculation impacting the company every day, BP is not for the squeamish. There are, however, relatively conservative ways to play the shares (using options) that assume a more limited risk than buying the shares outright for nearly $32 per share (or $3,200 per 100-lot). Two potential option trades in BP – one bullish, one bearish – are outlined below. Remember these are hypothetical examples, not recommendations. Consider your risk/reward parameters and trading goals before executing any new trades.

*Prices given as of Tuesday’s close. BP was trading at $31.91, up 8.7% on the day.

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Bullish Option Strategy: Bull Call Spread

Think the stock has been beaten up sufficiently for the oil spill? Consider a short-term bull call spread, which could benefit from a bounce back in the shares. The August 30/35 call spread can be bought for a net debit of $2.22 (by buying the 30-strike call and selling the 35-strike call). At expiration, if BP has rallied above $35, the investor collects the maximum potential profit of $2.78 (the difference in strike prices minus the debit paid). If BP has dropped below $30, losses are capped at 100% of the premium paid, or $2.22. Breakeven at expiration is $32.22.

Profit/Loss of BP bull call spread

Bearish Option Strategy: Put Backspread

Investors who have an extremely bearish outlook could consider a put backspread, also in the August series. An investor can currently buy two August 25 puts and sell one 30 put, collecting an overall net credit of 47 cents. In the near term, the spread will increase in value as the stock falls, with gains increasing exponentially below the 25 strike.

At expiration, losses peak at $4.53 (the difference in strike prices minus the credit collected) right at the 25 strike. The maximum gain, once the stock moves below the downside breakeven of $20.47, is theoretically $20.47 (if BP were to move all the way to the zero mark before these August options expire). Finally, above the 30 strike, gains are capped at the 47-cent credit collected. Note that in order to yield healthy profits, this strategy requires a downward move in the stock that is both dramatic and quick. The expectation with this strategy is that it will be closed before expiration.

Profit/Loss of BP put backspread