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ATP Oil and Gas (ATPG) has been in a tough position due to liquidity concerns and issues of management not being able to hit certain targets.

ATPG is in a tight spot because its interest expense is so high that its nearly impossible for ATP to turn a profit. The only way the company can turn a profit is by increasing production. However, since the company is running low on funds it's hard to believe ATPG will be able to remain solvent long enough to increase production.

The stock does not seem appropriate here as there is way too much uncertainty for the future of the company; nobody knows what is going on. ATPG even hired a CEO at the beginning of this month, and then he resigned a week later.

While the equity seems like a poor play, the bonds may be a much better buy. As ATPG's losses mount, the company could go bankrupt in the next two years.

Analysts such as Ravi Kamath have been saying that ATPG could file for bankruptcy as soon as November.

Their operating performance has been poor. There's somewhat of a chance that they have to file in November, when a $90 million coupon payment comes due. They've been able to do these liquidity enhancing transactions, which has kept them out of bankruptcy.

- Ravi Kamath, analyst at Global Hunter Securities

Kamath could be right, and he isn't the only one that believes ATPG could default soon. Moody's Investor Services said last September that current operating cash flow may not be enough to cover the company's bond payments.

In a bankruptcy scenario such as this, equity holders would be wiped out completely. Even bondholders may take a hit in a situation like this, but it's important to note that the bonds are trading at an extremely large discount to par value.

ATPG issued $1.5 billion worth of bonds at a par value of a $100. The bonds are set to mature on 05/01/2015. The CUSIP for the bond is 00208JAE8.The reason I recommend the bonds over the equity is because the returns could be great even if ATPG files for bankruptcy.

The bonds are trading at 50 cents on the dollar. The interest rate based on the $50 price is around 24%. So if ATPG still manages to barely scrape by, bond investors will be able to lock in a phenomenal yield. If ATPG is able to pay back the loan by 2015, investors will see a 100% appreciation in the bond.

The biggest reason for recommending the bonds is because they have limited risk even in the case of bankruptcy. Typically, if ATPG restructures, the company would wipe out the equity holders. Even the bondholders may not get everything, but I believe they will get much more than 50 cents on the dollar for the bonds. It's even possible that bondholders could agree to convert to the new equity if ATP defaults. This would cut out interest payments and save the company a $177 million a year.

Bottom line is that there is a possibility of ATPG going bankrupt. The equity should be for those with a high risk appetite. With the bond, investors can get a 24% yield, while expecting a limited downside in event of a restructuring.

Disclosure: I have a small position in CUSIP 00208JAE8.

Source: ATP Oil And Gas: Sell The Stock, Buy The 24% Bonds