Tim Bovee, Private Trader: BP: Bull play, longer-term rules

Update 11/5/2015: My short options in the covered call were assigned and I have exited the position entirely.

My holding period for BP encompassed two strategies: Long-term shares held for the dividend and hedged against downturns, and shares as a basis against which to sell covered calls.

In the entire holding period, shares rose by 4.8% over 60 days, or a +29% annual rate, and the options, including a hedge, produced a 12.8% loss on debit, or a -78% annual rate.

In the covered call period only, shares fell by 0.5% % over 52 days, or a -52% annual rate. The options position produced a 12.1% loss on debit, for a -86% annual rate.

Calculations for both periods include dividends.

Update 9/22/2015: I've rolled forward the $32 short call expiring Oct. 17 into a $31 short call expiring Nov. 20.

Update 9/8/2015: I've added to my BP position, lowering the basis and giving sufficient shares for me to sell covered calls against. I bought the shares for $31.34. The original purchase was $41.80, giving a basis of 34.48 on price alone.

Why stay with a stock that has fallen so far? I still consider BP to be a take-over candidate, an din the meantime, it has a dividend yield of 7.65% annualized at today's prices.

With the ability to sell covered calls against the position, I'll reduce my basis further.

And indeed, I did sell a call against the BP shares, with a strike price of $32 and a 62% chance of expiring out of the money for maximum profit. The call expires Oct. 17.

Update 3/11/2015: BP has dropped below its 55-day moving average and I've opened a bearish hedge.

Update 4/15/2015: I closed my hedge and shall calculate results BP shares plus its hedges when the entire position in unwound.

I've opened a bull position in the global fossil fuels company BP PLC (BP), headquartered in London, as a longer-term play.

[BP in Wikipedia]

I labeled the position as coming under my longer-term rules, but insofar as entry goes, it is, unabashedly, a punt, based on stories and speculation, and coming entirely outside the normal structures of my trading.

There is nothing hugely insightful about my reasoning. It goes as follows:

BP is largely a creature of oil prices.
Oil prices are recovering from their recent lows.
BP is troubled in other ways beyond those seen as its competitors.
Those troubles make it relatively cheap at a time when oil prices appear to be returning to the norm.
Therefore, BP can be seen as a good take-over candidate, providing an opportunity for windfall capital gains.
And in the meantime, it pays a high 5.74% dividend annualized at today's prices, making it an attractive income stream even if no take-over bid materializes.

I wrote about oil prices several times in January, in "The Crude Oil Crash" and "Crude Oil and the Black Swan".

My take-away is that the price decline, while significant, is not an end-of-the-world-as-we-know-it event, despite the lamentations of the Chorus of Market Analysts. I expected that oil would return to the mean.

BP has been in a sideways trend since the Great Recession low, staying within a channel that inclines slightly to the upside.

Click on chart to enlarge.

BP 10 years weekly bars

BP has a bearish rating from Zacks Investment Research

The company reports return on equity of 9%, with debt running at 37% of equity.

Earnings have been profitable in all of the past 12 quarters.

Nine of the quarters have produced upside surprises. The most recent of the downside surprise was in 2013.

The earnings yield is 2.86%, compared to a 2.14% yield on 10-year U.S. Treasury notes. The dividend yield is 5.74% annualized at today’s prices.

The "fair" price implied by earnings growth estimates is $21.21 per share, compared to the market price of $41.76 per share. The market premium is 97% above the implied price.

The stock is selling at 35 times earnings and also at a discount to sales. It takes 36 cents in shares to control a dollar in sales.

Institutions own 11% of shares.

BP next publishes earnings on April 28. The stock goes ex-dividend in May for a quarterly payout of 60 cents per share.

Liquidity

BP on average trades 87 million shares a day and supports a wide selection of option strike prices, which will make it easy to hedge any downturns in the stock price.

The Trade

I structured the trade as long shares.

Decision for My Account
I always consider story trades to be risky. However, despite the pessimism of the analysts, BP's financials aren't awful. Like all story trades, this one comes down to belief: If you believe that the rapid decline in oil prices since last year is a permanent change in the world economy, then I am fortune's fool for entering such a trade.
If you believe that the decline was a temporary occurrence caused by -- well, whatever: A sudden glut in the market? A loss of political will in the Middle Eastern oil producing region in the light of violent political unrest? The devastation of the Russia economy in the wake of western sanctions against that country's imperialism?

Story trading is like one of the old choose-your-own-adventure books: The trader crafts the plot, and the markets determine how well and cannily he has crafted it.

-- Tim Bovee, Portland, Oregon, Feb. 17 2015

References

My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

The directional score is calculated as the sum of the following:

Zacks rating --The Zacks ratings are translated as follows: 1=2, 2=1, 3=0, 4=-1 and 5=-2.
Enthusiasm rating --: A single percentage derived from the number of analysts whose opinions are in one of five categories: Strong buy, buy, hold, sell and strong sell.
Strong buy share -- The percentage of all analysts who rank the stock strong buy. If the share is 60% or greater, the score is 1; if 40% or less, then the score is -1; otherwise, the score is zero.
Ethusiasm momentum -- The score is 1 if today’s enthusiasm rating is larger than the rating 30 days earlier; otherwise, the score is zero.
30-day direction -- The trend that best describes the 30-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.
One-day direction -- The trend that best describes the one-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

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Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.