BP Dividend Cut Hurts Pensioners, Helps Options Trader Profit

16th Jun 2010 22:14

By Maxwell Murphy Of DOW JONES NEWSWIRES NEW YORK (Dow Jones)--Pensioners in the U.K. might be heartbroken about BP PLC's (BP, BP.LN) decision to skip three quarters worth of dividends. Options traders who believed the move was inevitable, however, made some quick money on the suspension. Jonathan Feldman, a private investor in Baltimore, is one of those sophisticated traders. Feldman noticed certain long-dated BP options were reflecting the risk of a BP dividend cut, but not fully pricing one in. So Feldman, sure that the mounting U.S. political pressure and criticism would force a dividend elimination sooner than later, devised a complex series of trades that would make him money if the dividend was cut very sharply, and even more if it was eliminated entirely. BP said Wednesday that it wouldn't pay the previously declared dividend for the first quarter, or the dividend for the second and third quarters, to shore up at least $7.9 billion to help it cope with the Gulf of Mexico oil-spill crisis. Here's one example that shows how the bet worked: This morning, before the announcement, Feldman sold short BP common shares at $29.87, pocketing that money. Then he built what's called a synthetic long position by selling October put options on BP with a $32 strike price, for $7.21 apiece, and buying October $32 call options that cost him $4.80 apiece. On the synthetic long, he netted $2.41 a share, which when added to the money from shorting the common stock works out to $32.28 a share. This locks in a situation where he can profit on the 28-cent discrepancy between what he received for the trades and the strike price, but only if BP doesn't pay a big dividend. Since short sellers are responsible for paying dividends on stocks they are short, any BP dividend of more than 28 cents would have caused him a loss, up to 56 cents a share if BP paid a second-quarter dividend at the previous rate of 84 cents. It was a heady strategy, and the amount of potential loss exceeded the amount of potential gain, so it's certainly not for the risk averse or newcomers to the world of options. But it proved a surefire way to lock in a profit if the dividend met its demise, and that's something that retirees who base their income on the BP dividend probably wish their brokers had set up for them. -By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; [email protected] (END) Dow Jones Newswires June 16, 2010 17:14 ET (21:14 GMT)