If it looks too good to be true, it likely is. And with warning signs both off and on the price chart for BP PLC (ADR) (NYSE:BP), a bear put spread for contrarian-oriented traders is well-positioned to take advantage of lower prices in BP stock. Let me explain.
The way BP stock has been trading of late, and even over the last couple years, it’s not a stretch to think hopeful and bullish shareholders are betting that leadership will continue and the price action is a leading indicator for better times ahead.
Since BP’s early 2016 low which challenged the technical bottom tied to the 2010 Gulf of Mexico disaster, shares have done well for investors by trading up roughly 45% sans its dividend. Yet, given oil and the likes of the United States Oil Fund LP (ETF) (NYSEARCA:USO) are deep underwater over the same period, obviously the correlation isn’t exactly robust right now.
Bearing that in mind, the contrarian in me believes there is more downside risk than potential upside from any rallies in BP stock. In fact, if USO was to rally strongly, the often perverse behavior of the market could find that leadership being undercut, with shares underperforming or even declining in price.
What could cause such a turn in sentiment?
Like with the Deepwater Horizon incident, a bearish catalyst could be an unforeseen event. On the other hand, it could quite simply be visible but ignored information, such as BP’s at-risk dividend, which InvestorPlace’s Bret Kenwell noted earlier this week. Earnings could prompt that conversation too.
BP Stock Weekly Chart
Click to Enlarge
On the BP stock weekly chart, my sense is that similar to the company’s hefty 6%-plus dividend being eye candy, the current uptrend and outperformance since early 2016 is at risk too.
With shares in a tight three-week consolidation test of its 2017 and pattern uptrend high, as well as overbought on the weekly stochastics, it’s time to think like a bearish contrarian.
BP Bear Put Spread
For like-minded traders seeing the potential for lower prices in BP stock, given mixed volatility readings and earnings early next month, a bear put spread is a favored way to position short in BP stock.
Reviewing BP’s options, one combination that looks up to the task is the Dec $38/$37 put vertical. With shares fetching $39, the spread is priced for 30 cents, or less than 1% of BP stock risk.
Bottom line, the vertical sharply reduces risks associated with options Greeks and per contract dollar exposure.
And as it also offers the a bearish trader the benefit of owning a limited-risk position with a potential profit capture of 70 cents, or 233%, at $37 or just 5% below BP stock’s current price at expiration. The reality is this spread can yield nice gains without even becoming headline news.
Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits and feel free to click here to learn more about how to design better positions using options!
