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BP (NYSE:BP) is in the process of transforming itself by emphasizing safety and focusing on high margin market segments. As an example, the company recently agreed to sell its Carson, California refinery business to Tesoro (NYSE:TSO).

BP has been through the wash since the 2010 Deepwater Horizon disaster in the Gulf of Mexico. On a positive note, the company noted in its Q2 2012 earnings call held on July 31, 2012 that it has contributed nearly $18 billion to the disaster trust with the final payment scheduled for the fourth quarter of this year, which will complete the $20 billion fund. However, if the U.S. Department of Justice (DoJ) has its way, the $20 billion might not be enough to take care of the situation, as the DoJ believes it can prove gross negligence, which could up the cost. The U.S. DoJ trial is scheduled for January 14, 2013, so we'll have to wait a while to determine the final outcome.

BP's problems are not confined to the Gulf of Mexico, as it has been having problems related to its join ownership of Russian oil company TNK-BP. TNK-BP is Russia's third largest oil company, and due to Russian law, BP is limited to 50% ownership of the company. In the second quarter, BP's net income attributed to TNK-BP was 58% lower than last year and 61% lower than the previous quarter. BP noted it has received unsolicited indications of interest regarding the acquisition of shares of TNK-BP, so with a sale of TNK-BP, BP could relieve itself of its TNK-BP problems. However, BP noted that even with a sale of its interest in TNK-BP, it intends to continue to be involved in the Russian energy sector.

BP's second quarter results were weak and the weakness was attributed to volatile trading conditions resulting in lower oil prices, lower contribution from U.S. natural gas due to low prices and a large planned maintenance program undertaken to enhance safety and reliability. BP noted the U.S. price of natural gas had dropped as low as $1.94/Mcf, but had recovered to around $3.21/Mcf. The company indicated natural gas prices outside of the U.S. have held up due to continuing strong demand for liquid natural gas in Asia.

BP expects a weak margin environment for the remainder of 2012. The company's outlook for the third quarter was muted as it noted its top four high-margin business segments will be slightly down in 3Q relative to 2Q. Additionally, the third quarter will be negatively impacted due to continued divestment efforts for reshaping the company. BP's outlook for the fourth quarter was brighter, as the company expects production to rise in the fourth quarter as the summer maintenance program is completed.

The company has a pipeline of 15 projects scheduled to start at the end of 2014 which is expected to be significant drivers of cash flow growth. Additionally, the company is on track to start six new projects this year.

BP's stock price has been in a trading range over the last year and is currently in the middle of the trading range as shown below:

(click to enlarge)

The prospects for BP appear bright, but the company has to get by a few bumps in the road, such as the U.S. DoJ, before realizing its goals. Until the U.S. DoJ case is settled, BP's stock price will probably be treading water, so an investor might consider entering a protected covered call. A protected covered call provides positioning for a potential return, even if the stock price is stagnant, and provides protection in case the stock price takes a hit. The protected covered call may be entered by selling a call option against the stock and using some of the proceeds from selling the call option to purchase a put option for protection.

Using PowerOptions, a variety of protected covered call positions for January of 2013 are available for BP as shown below:

(click to enlarge)

The positions in the table above do not include consideration for received dividends. The top position looks attractive as it has a potential return of 3.7% (10% annualized), including receipt of expected dividends, and a maximum potential loss of 6.4%. Even if the price of the stock plummets to zero, the maximum potential loss is 6.4%. The specific call option to sell is the 2013 Jan 41 at $2.51 and the put option to purchase is the 2013 Jan 37 at $1.30.

BP Protected Covered Call Trade

  • BP stock (existing or purchased)
  • Sell BP 2013 Jan 41 Call at $2.51
  • Buy BP 2013 Jan 37 Put at $1.30

A profit/loss graph for one contract of the BP protected covered call is shown below:

(click to enlarge)

For a stock price below the $37 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increases to $45 or greater, the position can most likely be rolled in order to realize additional potential return.

Source: BP: Transformation Takes Time