Will Investors Return to BP (NYSE:BP)?

Option strategies in BP (BP) The hope when setting low expectations, of course, is that the eventual result will be better than everyone feared. We see this with earnings guidance figures, sales numbers, and all measures of financial forecasts. BP is currently seeing a version of this phenomenon take shape. The oil giant now says the $20 billion it earmarked for legal claims related to the Deepwater Horizon disaster may be more than sufficient.

Some analysts believe BP, which is under the new executive leadership of Robert Dudley come October 1, may resume paying a reduced dividend in the fourth quarter after three periods of non-payment. Other BP watchers believe dividends won't begin again until the first quarter.

BP is at an important precipice; will the company in fact have better cash reserves than initially estimated? Will BP investors be treated to quarterly dividends sooner rather than later? Encouraging news out of the BP camp could be enough to buoy the shares above their early-August peak and into territory not explored since pre-Horizon explosion.

If further disappointments loom ahead, however, it's a short trip below technical support at the 50-day simple moving average (SMA). BP bears may be quick to pounce at any renewed sign of weakness.

No matter which side of the BP argument you favor, option strategies could be something to consider in lieu of buying (or shorting) BP shares. Below are examples of a bullish strategy (a cash-secured put) and a bearish strategy (a bear put spread). These should not be considered trading recommendations but merely demonstrations for educational purposes. All prices are as of Monday afternoon. BP was trading at $38.42, up 20 cents on the day.

Bullish Option Strategy: Cash-Secured Short Put

BP bulls (especially those who wouldn't mind owning the stock on a pullback) could consider selling the January 37 puts for a credit of $2.50 apiece. If BP rallies, stays put, or even declines slightly through January expiration, the investor keeps this credit as profit. This premium equates to 7.25% of the cash required to secure this trade through expiration, or 14.7% annualized.

If BP is trading below 37 when the options expire, the put seller will likely be assigned and required to buy the shares. The equivalent price of the stock buy would be $34.50 (the strike minus the premium collected). To “secure” this put with cash, set aside $3,450 for every put contract sold, thereby ensuring the cash is there to purchase the shares if necessary. Breakeven and maximum loss for this strategy are also $34.50, giving BP more than 10% of wiggle room to the downside before the position enters losing territory. The charts below are created in a virtual trading account.

Bearish Option Strategy: Bear Put Spread

Those who are skeptical toward BP, at least for the short term, could buy the October 35/40 bear put spread (buying the 40 put, selling the 35 put). The net debit required to purchase this spread is $1.90, which is the most the investor can lose if BP is trading above $40 when the options expire in roughly 31 days.

At expiration, below the breakeven point of $38.10 (the long strike minus the debit paid), the spread begins to earn profit. Profits are ultimately capped at $3.10 (the difference in strikes minus the premium) if BP is trading at $35 or below. Return on risk for this spread is 163% in just about one month.

Profit and loss of BP bear put spread