BP Calls Could Deliver Some Slick Profits

Catching a falling knife can be done, but generally speaking, investors get cut up trying. Troubled stocks tend to stay troubled, and BP plc (NYSE:BP) is the ultimate example of this.

Even if BP manages to fix the Gulf of Mexico disaster, it will not be out of the woods for a very long time. But what about looking at an options trade that is hopefully out past the stock-crushing day-by-day headline reactions?

BP's ADR has been the worst performing of the major integrated oil companies. The shares were up more than 4% at one point today, taking the stock above $38, but the 52-week range is $36.20 to $62.38.

You can forget about trading the front-month options. In fact, you probably need to look out six months or more.

Using the old $1 rule is probably not a good idea with this one, as the BP Jan 2011 50 Call (BP 110122C00050000) is far enough out and gets close to $1 (about $1.30 today), but the $50 strike requires a 50% recovery of the losses since the disaster started.

The BP Jan 2011 46 Call (BP 110122C00046000) at $2.45 is not a traditional on-run call, but it is where the sweet spot is in terms of compression of time value and headline risk for the premium on each contract. This contract can be added in slowly as a longer-dated speculation.

If the shares drop again, something very possible while the near-term headline risk is present, then the $45 strike could be looked at.

If BP manages to get this disaster even somewhat more under wraps, then the stock could easily jump to $40 or higher even though it will continue to have corporate brand image problems. If the bloodletting slows down in the stock, and if it can get more recapture handled in the near-term, these January $46 strike calls could be worth more than $4. And the real bleed-off from time value erosion will not really become a factor until after this summer.

BP has seen a widening out in its credit-default swap spreads. That is no call for a bankruptcy, but the cost of insuring against the worst-case scenario has gone up. The recent capture rates are starting to help in the Gulf clean up, but this is far from fixed, and the situation is not even close to being over.

As for the dividend risk, some politicos are calling for BP to drop its dividend, which could further punish shares as investors look for a safe yield elsewhere. Many oil companies have done nothing to try to diversify away from fossil fuels, and some that did were accused of being "greenwashers." If there is one oil company that made many investments early on in solar power, it is BP.

This is no miracle call here, but it is a way to gain upside exposure without as much risk

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