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Is BP Ready to Rebound?

Since my posts about BP have been quite popular recently, I thought I would comment on this article on Yahoo Finance. The article talks about how BP may be able to cap the well in the next few weeks. As I mentioned in the first post about BP, usually the market overreacts to bad information.

In this case, it turned out that the situation was really bad, in fact it is the worst oil spill in history. And the blame is landing squarely on BP.  The share price has gone down since the accident,  and it seems that the well will be plugged soon. Although we now know the massive damage caused by the well, it seems that BP’s share price may be turning around.

Does this mean that the price is heading back up?

Nobody knows. But here are some ideas about how to make money from the situation.

First, I think it is important to notice that the accident was a Black Swan event: no one could have predicted that the worst oil disaster in history would occur. However, once the stock started going down and there was no likely solutions to the problem, it may have been a good time to trade BP stock.

One way would have been to sell BP stock short. That means that we make money as the price goes down. Another way would have been to buy put options. This leverages the bet so that both the potential payoff and potential loss are higher. Although options require much more care and education that buying and selling stock, anyone who is committed can learn to trade them.

We can see that the price fell from 60 to 27, a drop of over 50%. If you think that the well will be capped soon and the stock will rebound, then it could be a good time to buy stock. When I first mentioned the stock, one of the attractive things about it was the yield, which would be about 9% at the current price. However, BP has stopped dividend payments (at least temporarily) and we really don’t know when they will be continued. One thing is clear: the cost of the cleanup will be massive.

One short term trade would be to buy call options. Similar to buying stock, this is a bet that the price will go up. The option provides leverage so that if we are right we can make much more money than by simply buying the stock. However, the chance of losing all the money that we put into the trade is much greater as well.

We can’t know if the stock is going to continue going down, or if it has just turned around and started going back up. However, we can learn to make the best of the situation. That means that by understanding our risk, we can choose a bet that will make the most amount of money given the loss that we are willing to risk. We need to choose a trade and a position size that fits those two requirements.

Ultimately, learning to be successful trader takes time and dedication. The good news is that anyone can do it. It is only a matter of committing enough time and energy to become proficient.

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  1. July 9th, 2010 at 13:05 | #1

    An observation -
    If you believe BP can go back to $60 by Jan 2012, here’s a strategy:
    Buy the $50 calls for $3.15 and sell the $60 calls for $1.30.

    Your net cost is $1.85 or so, and if BP closes at $60 or above in Jan’12, you have $10. Nearly a 5X return.

    The question is – how much of an over-reaction was this? By the way, the $40-$50 spread can be had for $3.20. So a recovery to $50 is a 3X return.

    The options market often trades on formula, theoretical value, and ignores the black swans or their rebounds. This is not a recommendation, just an observation.

  2. July 9th, 2010 at 14:06 | #2

    I considered buying BP stock at the bottom to see if I could catch a dead-cat bounce. But, I am still nervous of this strategy, after getting BK’ed out of GM and Fanny Mae.

    Today, I read an article from 24/7 Wall Street that said BP will be one of the 10 Brands Likely to Disappear. They feel BP will reorganize to shield their assets from the liability of the spill. That makes a lot of sense for them, so I am avoiding their stock.

  3. November 9th, 2010 at 23:45 | #3

    If I was going to buy a BP stock I would wait until the BP stock plunges a little further to buy it. My verdict would be buy it in a couple months. Why? because at the moment BP is dealing with a crisis and Obama just handed them a $68 million bill for clean up, and the costs are going to continue to increase for BP. But they are a giant, and in a few months they will be right back on their feet again, even after this disaster

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