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Long BP Dec 24 520/560 Call spread financed by a Dec 24 320 Put
Since the onset of the Middle Eastern conflict, oil prices have dropped 7%, as the market downplays the risk of escalation. Investor pessimism stems from uncertainty around the supply and pricing of key OPEC members, anticipation of subdued demand, and depletion of the US Strategic Petroleum reserves. Despite the ongoing geopolitical tensions impacting global macroeconomics, the market appears to lack a risk premium on oil. We see the underappreciated risk mainly in Iran's control of the global oil supply through the Strait of Hormuz, responsible for over 20% of global oil supply. Although the geopolitical risk premia in oil currently appear absent, there has been notable renewed buying activity since the beginning of the year. BP is one of the stocks with the highest sensitivity to changes in Brent Prices and is currently trading at price support levels. Out of the money calls skew is relatively rich e.g. 1Y 100-110 call skew at 1.1v is a 2Y percentile of 7 (presumably the low absolute vol mark and market positioning for tail risk from higher oil prices driving upside hedging), in turn favouring the use of call spreads. At the same time, we would look to partially finance the strategy by selling downside puts. Whilst the absolute vol mark isn't particularly high, the valuation argument (320 put would be 5.2x PE/c.6.7% dividend yield) sways our thinking to finance the structure. 560 strike is the 5-year price resistance level while the 520 strike provides a higher risk reward than buying lower strikes. Buying the 500 strike would increase initial cost to 1.46% and decrease max pay-out to c.9x. Putting all of the above together we recommend buying the 520/560 Dec24 call spread vs selling the 320 put at a cost of 0.34%. Should the market tick through our target price by expiry it will deliver a c.27X return on premium employed. Alternately you are left long the stock at levels last seen in January 2022 before the Russian Ukrainian war. |