Shadow Stocks - Investing, with a focus on small stocks

From Cramer (for whatever it's worth)...

Stocks discussed on the lightning round session of Cramer's Mad Money TV Program, Tuesday March 23.

Bullish Calls

BP Prudhoe Bay Royalty Trust (BPT): "The stock had an unbelievable decline of 10 points on Friday… it looks like some seller mistook, some seller got it wrong… he dumped the stock… all of the buyers stepped aside.. It was one of the great buying opportunities I have ever seen…"

Any news on BPT? It went up huge during normal trading and then fell about $3 after hours today.

There was this around noon, from an outfit called Indie Research, "Royalty Trusts King of Distribution Hill", which included this line,

Meanwhile, energy giant BP's (NYSE: BP - News) subsidiary BP Prudhoe Bay Royalty Trust (NYSE: BPT - News) yields an incredible 16% based on annualization of its most recent distribution.

BPT is at $87.90 right now, after dropping ~8% today, and these puts are at $6.30, after rising ~70% today.

Dave,

At the 4 PM close of $85.05 your shares had dropped $12.83 from your write-up price of $97.88.

The September $85 puts had risen in value from $3.50 to a last bid price of $6.50 and a last trade price of $6.70.

Your hedge had only protected you by $3.20 /share - not nearly enough to offset the $12.83 decline so far.

Paul,

I own more puts than shares in this case, so the hedge is worth more than that, but the goal of the hedge wasn't to hedge against any draw down, but against a particularly large one. Ideally, BPT will drop a little more between now and the next distribution, so I can get more shares when I reinvest. My average cost on the units is in the low $50s now.

I'm curious what you're reasoning is.

If you're still holding BPT you must think it still has upside and you're buying the Sep. $85 puts to hedge your long units.

You're still exposed to the first 16.7% drop, though, while also giving up $3.50 /share (3.6%) of any upside as the cost of the protection.

Where do you feel BPT is most likely to go between now and Sep. 17th? Even that 8.7% projected yield is probably generous enough to prevent a large pull-back.

I could easily see it pulling back to the mid-80s between now and then. 8.7% is a nice yield, but bear in mind that the last quarterly distribution was about $3.60. When new buyers see the next one clock in at closer to $2.15, they might sour on it.

Another course of action, of course, would have been to just sell my stake here and buy it back after a dip, but this seems like a safer bet. The distributions more than cover the cost of the puts, and if the trust has a big dip between now and then, I can sell the puts and use the proceeds to buy the units on the dip. I could be wrong though. We'll see.

If BPT does go back to $85 as you think possible then your $85 puts will still be worthless at expiration and you'll have suffered a 16.7% drop in the value of your shares plus the cost of the puts.

Unless you see a much bigger dorp coming I don't like this strategy.

If you do see a larger dip... why continue to hold at all?

It just closed at ~$85 today. Can't say I expected that this quickly, but I'm glad I was hedged.

All options are worthless at expiration. I plan to sell these puts before expiration.

The reason I continue to hold is that I am not sure if there's going to be a larger dip, and as long as I hold, I keep getting paid. I am literally hedging my bets here.