How to Make a 59% Dividend From BP
Companies / Options & Warrants Jun 08, 2010 - 12:17 PM GMTBy: DailyWealth
Tom Dyson writes: The Gulf of Mexico oil leak is a disaster for the environment, a disaster for the local economy, and may even prove to be a disaster for the stock market if the government decides to punish the offshore drilling industry.
But it could be the best thing that happens to your portfolio this year...
Today, I'm going to show you how to use the Gulf oil disaster to generate a 59% dividend. This is a unique trading opportunity using "stink bids." It's a little bit unusual, but it's worth taking the time to understand.
British Petroleum is the fourth-largest company in the world behind Wal-Mart, Exxon, and Royal Dutch Shell. It operates in 30 countries, generates $240 billion in annual revenues, and owns 22,400 gas stations.
The massive underwater oil leak in the Gulf of Mexico is the worst environmental disaster in America's history. And British Petroleum is the company responsible.
Right now, thousands of lawyers in Florida, Alabama, Mississippi, and Washington DC are rolling up their sleeves and preparing to sue BP for every cent they can get their hands on. This is shaping up to be one of the biggest corporate legal actions since asbestos and tobacco.
The stock market hates uncertainty. In this case, BP investors have no idea how much money BP might have to pay to clean up the mess. It's simply impossible to predict. (I've seen estimates for the total long-term liability ranging from $2 billion to $37 billion.) This uncertainty has caused a massive drop in BP's share price.
I downloaded BP's most recent annual report and did a quick diagnosis of BP's finances...
BP generates $30 billion a year in profit from operations. It reinvests $20 billion a year in its business and pays $10 billion a year in dividends to shareholders.
On top of BP's colossal ability to make money, it has a fortress balance sheet. BP has equity on the balance sheet of $104 billion, but only $24 billion in debt. With this low debt ratio, it has room to add at least double its debt load. BP also has $8 billion in spare cash to cover immediate expenses relating to the oil slick.
BP generates billions of profits each year on top of an awesome pile of accumulated wealth. In short, even if the oil spill ends up costing BP $37 billion, it won't have trouble paying the bill.
That said, even though BP is a rock-solid company and can easily afford its legal bills, I don't recommend you buy BP's stock at today's prices. Investors are in panic mode and you simply can't predict how much lower BP's share price will fall.
Instead, you should enter a "stink bid" on BP. When you make a stink bid, you're offering to buy a stock for way less than current prices. In return for making this offer, the market will pay you cash, upfront.
Let's say you set your stink bid at $33 a share – more than 10% below today's price – the market will pay you $2 for every share of BP you agree to buy. Your agreement only lasts through mid-July. So your $2 amounts to a 6% profit in five and a half weeks... or a 59% annual dividend. You collect this cash payment whether or not your stink bid gets hit.
If the market hits your stink bid, you'll own BP at a great price... Despite its legal troubles, BP is one of the largest, most profitable oil companies in the world.
So how do you place a stink bid? You do it through the options market, by selling a put option. Someone who sells a put is agreeing to buy a stock at a particular price. Selling "out of the money" puts is how you make a "stink bid." You get cash upfront for selling a put. And you agree to buy the underlying stock at a price way below where it's selling today.
In the example above, you'd sell the July $33 put and collect about $2 per put option you sold.
If you're new to options, this may sound confusing. But when investors panic, like they have with BP, it can be the safest income strategy in the world. It's worth doing some homework to get up to speed. Call your broker. Check out Yahoo's put primer here and Wikipedia's here (scroll down to "naked put").
With BP today, you have the opportunity to make the equivalent of a 59% annual yield. The big risk here is that the situation suddenly deteriorates and BP's stock collapses.
But with BP's massive financial resources and all the bad expectations already priced into its shares, the market is compensating you handsomely for taking this risk.
Good investing,
Tom
P.S. If you like the idea of collecting big income through the options market, there's nobody better to have on your side than my colleague Jeff Clark. Jeff thrives on the volatility we're seeing in the market these days, and he has perfected the art of grabbing large cash payments – safely – by selling options. Read more here.
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