Bearish News

2012 BP puts offer some interesting possibilities. I’m using them as a speculative bet on a worst-case Gulf scenario, but they could also make a nice hedge for longs.

Jan ’12 BP LEAP puts expire 566 days from today (7/14/2010). That’s a lot of time for something to go wrong.

For example, there will be two hurricane seasons between then and now. Just one poorly-placed hurricane could push millions of gallons of crude further into sensitive areas along the Gulf Coast, multiplying the eventual bill for BP. Warm water conditions mean NOAA is forecasting an abnormally high 13-23 named storms in the Gulf of Mexico in 2010.

Potential Profit from BP Puts

Let’s use Jan ’12 $2.50 BP puts as an example. They closed with an ask price of $0.16 today. One hundred contracts at that price would cost $1600 + commission. Each put gives its holder the right to sell 100 shares of BP stock at $2.50 on date of expiration (Jan 21 2012 in this case).

If BP shares are wiped out, the maximum potential profit on 100 $2.50 puts would be $23,138 (assuming a $.02 share price at option expiration). Max loss is the initial cost of the puts, $1600 + commission.

So the max ROI would be 1446%, or around 14x the initial investment. BP filing for bankruptcy is still a highly hypothetical scenario, but I think the risk/reward ratio is good here.

The fact that you can make 14x your money on these options means investors are essentially betting on a 1 in 14 chance of BP going bust by the expiration date, Jan 21 2012. I think there’s more like 1 in 4 chance of bankruptcy, hence the bet.

Buying the $2.50 puts is an aggressive strategy. It’s betting on total disaster. A more conservative strategy use puts closer to the money ($15, $25, etc). The potential upside would be less, but it’s a little bit safer. I own a few different 2012 strikes, including some $2.50s.

BP is an international giant with deep pockets and political clout to match. But its risks are high too. The litigation costs alone will be staggering. Other potential potholes include legislation, reputation, well casing degradation, environmental devastation, and other “ations” we have yet to fully grasp.

On the legislation front,  today the U.S. House Natural Resources Committee passed an amendment which could effectively ban BP from future offshore drilling leases. More on that over at Bloomberg BusinessWeek.

For BP, it all adds up to unknown liabilities, slower growth, and higher drilling costs going forward (no more shortcuts, hopefully). That’s why I think that even a behemoth like BP could buckle under the weight of this mess.

Bankruptcy Scenario

One big question that would emerge from a BP bankruptcy is how claim seniority is handled. Would bondholders and other creditors retain seniority over economic and environmental claims?

I’m guessing common shareholders would be wiped. But a Bear Stearns-esque buyout, with Exxon or Shell reprising the role of J.P. Morgan and U.K. gov’t subbing in for the Yanks is certainly possible. We won’t know until the situation plays out and the full extent of the damage is known.

Further harm to BP investors would be unfortunate. It’s a staple of retirement funds and the demise would have widespread financial impact. However, if it comes down to a lack of funds at some point, it would be an even greater tragedy to punish innocent parties adversely affected by the spill, and shortchange cleanup efforts in favor of investors. An investment comes with risks, always. If someone has to suffer, it’s gotta be stakeholders of the at-fault party.

But that probably won’t happen based on what I’ve read. In the fallout from asbestos/mesothelioma bankruptcies, creditors were placed above victims in most cases (as I understand it). More on that here.

Disclosure: Long BP puts including Jan 2012 $2.50s.
Note: This is NOT financial advice. It is provided for informational purposes only.

• Bought more GOOG this week, it is really really cheap here. I wrote a bull-case article for Wealth Daily on Tues.
• Re-shorted BP today @ $32.50 with a stop @ $36. Still holding some pure gamble 2011/12 LEAP puts at multiple strikes ($2.50 to $29).
• Bought XOM this week, partially as a pair to the BP short, but mostly cause it looks cheap and I needed more energy.
• Trimmed AAPL to near the bone, used proceeds to buy GOOG. Recent developments in China may look bad for Google, but I think they’ll be worse for Apple in the long run (labor costs set to skyrocket).
• Trimmed PGJ (domestic-driven Chinese ETF) a bit. Nothing against this China really, just finding other options more attractive and taking some profits.
• Bought Acergy (ACGY), a Norwegian offshore drilling services firm. Among other things, ACGY are some of the guys who run those ROVs hovering around BP’s Macondo well. Co. just merged with Subsea 7, which should work out well for both parties.

Anyone else got ideas? This market is obnoxious.

Karl catches some suspicious activity in the futures markets, live.

I’ve never traded futures, but this does seem pretty sketchy. I’ve followed Karl for a while, and he is a smart dude. Any other explanations for those bids appearing like that? You gotta assume huge bids like that could mess with the lesser algos, at least.

One thing we’ve learned about the Gulf oil spill is how opinions tend to differ depending on which side of the Atlantic you reside on. Compare these screenshots of the respective homepages of the New York Times and London’s Sunday Times.

NYT’s homepage highlights BP CEO Tony Heyward’s yachting trip (taken 6/20/2010 3:50pm EST, crude MS paint additions in red are mine):

London’s Sunday Times fires back with “Obama’s Golf Days Fuel BP Row” (requires login) on their homepage (SS taken on 6/20/2010 around 4:00pm. Once again, the crude MS paint additions are mine.)

Both are bone-headed moves. Everyone should be focused on this disaster, especially considering what we’ve learned over the past few weeks. 100,000 barrels per day and possible well casing failures dictate that.

Watching this situation play out will be both fascinating and nauseating. One of the biggest questions going forward may prove to be:  Is BP too dangerous to exist? I’m starting to think so. Their safety record is horrific.

BP continued to cut corners even after recent disasters, as the NYT points out here. In contrast, after the Valdez incident, Exxon transformed their culture into one where OCD-level safety concern is encouraged. I’m starting to think BP shouldn’t even be entrusted with the relief wells and a head-role in the cleanup efforts.

Disclosure: I am short BP and own long-dated, out of the money puts).

Guest post by Stefan Karlsson, economist of the Austrian School.

Some people think that employment statistics reflect direct government knowledge of all labor related transactions, and of the absence of labor related transactions, in a similar way that the government directly know how much revenue and expenditure it has had. But at least not yet, “Big Brother” isn’t that big.

So, employment statistics is instead based on surveys (polls). In the case of employment statistics this means in most countries surveys based on household respondents.

Unlike in most other countries, the United States government tries to compile two different employment surveys. One is based on the standard international method of household surveys, and the other is based on a survey of employers (the payroll survey).

Usually the message from the household survey is pretty much the same, though the exact details almost always differ somewhat. The latest employment report however had two different messages. The household survey indicated a very weak economy, as despite massive Census-related hirings, total employment actually fell.

By contrast, the payroll survey had a bullish undertone. While private (non-Census) payrolls increased only marginally, total payrolls increased significantly and both the average work week and average hourly earnings increased, suggesting a relatively solid recovery.

Since the survey results differ, and since there is only one reality, it follows that at least (maybe both) one of them is wrong. I don’t know which one of them is more accurate, but based on other reports it seems likely that the truth lies somewhere in between, which would imply a continuing U.S. recovery, but only at a moderate pace.

Read more of Stefan’s excellent economic analysis at his blog or view some rather prescient articles he wroter for Mises.org.

The humble and wise Mr. Faber talks to Bloomberg TV. Highlights:

• “Quite a lot” of technical support on the S&P 500 at 1045
• Stocks are oversold near-term
• “Quite happy” to hold physical gold over other asset classes
• There was no real recovery, look at tax receipts — they are lower YoY
• June/July rally is likely, but won’t go above major resistance at 1220
• Market will probably be lower by late Fall 2010
• Fed will use strong bond market to ease “massively”
• Banks worldwide would be “gone” if not for massive government support and easy money
• Still very bearish on U.S. economy long-term, due to banksters ruining economy (my slightly-biased take on what he said)