Market Overview

Will BP's Past Forever Haunt the Company?

Throughout the summer months of 2010, BP (NYSE: BP) was at the forefront of global news. Along with Transocean (NYSE: RIG) and Halliburton (NYSE: HAL), BP failed to maintain control over its operation in the Gulf of Mexico and managed to perpetrate the largest man-made natural disaster in history. The spill has since been contained, but permanent damage has occurred to the region, forever affecting the local wildlife, fisherman and other coastal business owners, and the men and women directly involved with the oil companies themselves.

BP was forced to pay millions of dollars in damages and legal fees due to the matter, and the disaster resulted in a fairly large setback for the company. Moreover, the company lost one of its main revenue streams, as they were never fully operational in the Macondo region again. During the fiasco, BP's stock price largely reflected consumer sentiment of the company. The stock dropped from about $60 to roughly $27 within a couple months.

After the disaster was alleviated, at least in the mass media's eyes, BP's stock managed to rise back up to about $40. Since then, investors have been wondering if BP is a clear buy that is undervalued, simply because of the oil spill's stigma. The company's stock has been volatile during the 2011 trading year, but some could attribute that to overarching macroeconomic trends.

Recently, however, certain news came out that may help traders figure out a definite direction in BP's stock. The US Department of Justice has come out and stated that it may prosecute BP employees directly involved with the incident. Criminal charges, which ultimately amount to felonies, are being considered against several Houston-based engineers as well as supervisors. Charges are expected to be formally announced in early 2012.

In a criminal court case, especially one involving a high profile company like BP, all the evidence will be brought to the table. The prosecution will try to nail the defendants down to the ground, while the defendants will obviously try to bring evidence that mitigates their involvement in the disaster. This type of evidence will most likely blame other individuals or the company itself.

The whole matter is speculative. If the Justice Department actually brought charges against the BP personnel, BP would most likely trade downwards. However, there is no confirmation and rumors are simply rumors. However, should investors play it safe and unwind their current positions in BP?

Investors have several choices to protect themselves from the possibility of legal action. First, they could unwind their current position. If they did not want to do that, they could implement a few options strategies to hedge their bets. They could write covered calls, which may be the most straightforward course of action for shareholders. Investors could also purchase puts; investors could do this if they have or do not have an equity position in BP.

Investors could also make a non-directional bet and instead bet on volatility. Purchasing straddles or strangles in the early months of 2012, in anticipation of an announcement by the Department of Justice, could be an alternative strategy. However, this may not be the smartest strategy, as any formal charges would be extremely negative announcement for the company and would adversely affect the stock. As such, investors have no reason to purchase call options and may as well stick with put options.

Investors have to keep an eye out on BP, because any concerns of legality could present two opportunities for them. First, an interesting shorting opportunity for the company. After the media is finished covering BP, the stock may be at a price that presents an interesting buying opportunity. As of now, though, all talk is simply speculative and may never occur.

Regardless of what the Government does, traders will be able to profit from any comments made regarding BP. While the overall economy may not fluctuate, independent traders can make money if they pay attention to the news. If traders keep up with the news on a real-time basis, they may be able to capitalize on short-term movements in the equity markets.

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ACTION ITEMS:

Bullish View:
Traders who believe that BP employees will not face criminal charges might want to consider the following trades:
  • Long BP via shares or call options because it is at relatively undervalued levels compared to direct competitors.
  • Long Transocean or Halliburton, because these two companies' stocks will probably move closely to BP's stock, based on consumer sentiment regarding the court case.
  • Purchase straddles on crude oil, which may react wildly if positive or negative news comes out.
Bearish:
Traders who believe that BP employees will be charged may consider an alternate position:
  • Short BP or hedge existing equity positions via options strategies.
  • Short Transocean or Halliburton, which could be implicated in the court case itself and may even be prosecuted as well.
  • Place non-directional bets on an ETF tracking crude oil, like the United States Oil Fund (NYSE: USO).
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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