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BP PLC (SYMBOL: BP) closed at $40.03 on 11/16/2012 and has a current dividend of $2.16 for a dividend yield of 5.40%.

The company right now could represent a strong long term bullish bet in the major oil space. Why would it be a strong bullish opportunity?

Consensus earnings estimate for the 2012 and 2013 fiscal year are at $4.95 and $5.20, respectively and would price in EPS of $8.08 and $7.69, respectively.

There is two potential shortfalls in consensus analyst estimates that are potentially underestimating the EPS potential for 2013. Revenues and EPS estimates for 2013 are factoring in lower oil and natural gas prices; which is likely to be overly conservative.

Natural Gas prices in 2012 traded at historically low prices due to the storage glut and needed coal to gas switching to encourage demand from coal to gas switching in the power generation sector. Given a normal winter (average temperatures) in 2012 and 2013 this would likely cause natural gas prices to further increase or remain flat at their current prices at $3.79 for the next few quarters. Natural Gas prices from January through August 2012 had an average settlement price of $2.55; which puts natural gas currently 48% higher than seen during the first 8 months of 2012.

This will help to bolster or at worst case provide a floor to revenues and EPS estimates that will help to offset any potential oil price decline due to poor economic results.

The other potential shortfall in consensus analyst estimates is the factoring in of flat to lower oil prices in 2012. Turmoil in the Middle East or better economic results could push oil prices higher in 2013 than seen in 2012 and result in improved revenues and earnings from oil.

The 52 week high of $48.34 should be revisited in my opinion by the end of January 2014 if oil and natural gas prices see the improvement as mentioned above. Worst case with better economic results and flat commodity prices the shares of BP should at least see $44 per share before the end of January 2014.

At $40.03 and based on the $5.20 in EPS this puts the shares at a buy in my opinion especially when you factor in a $2.16 dividend. A smart way to gain bullish exposure is to use January 2014 options to reduce risk while enhancing returns.

The trade I favor is to buy shares in BP at $40.03, sell January 2014 $45 calls at $1.87 and to sell January 2014 $30 put options for $1.85.

This is a pretty strongly favored bullish position as one is looking to get long shares and agreeing to buy more shares at $30 by the end of January 2014. However, the trade does reduce risk and enhances the return for the long term investor.

The cost average breakdown for the trade looks like this:
BP Long Shares at $40.03 - $2.16 (Dividend) - $1.85 = $36.02 cost average
BP Short Put Options at $30 - $1.85 (net credit) = $28.15 (if below $30 per share on Jan 2014 expiration).

At the worst case (shares below $30 per share) the long term investor would have a cost average in BP of $32.08 versus the current share price of $40.03 or roughly 19.86% lower.

The best case returns for the trade would be if share prices on January 2014 expiration were to be above $45 per share. The returns in that best case scenario would be $2.16 in earned dividends, $1.85 in net credit premiums collected from the short $45 call options, $1.85 net credit premiums collected from the short $30 put options and $4.97 in capital gains ($45-$40.03).

This would put total profits at $10.83 per share (assumption that the short put option shares are never assigned) or a return of 30.06% in just over a year's time.

Overall, the trade mention above reduces the investors risk by 19.86% and produces a 30.06% return if BP were to trade 12.41% higher by January 2014 expiration.

Source: BP PLC: A Long-Term Bull Trade While Reducing Risk