Deep Water Horizon

The Deep Water Horizon oil spill tragedy in the Gulf of Mexico connects strongly to Northwest Indiana (NWI). As a long-term employer in the area, many NWI families have accumulated and owned BP stock (formerly Amoco) for generations and the healthy BP dividend provides income for retirees and widows, some with their entire retirement savings invested in BP stock.

While BP stock has ups and downs, it has been comfortable enough to own, leading many in NWI to ignore diversification rules and have 90% plus of their portfolio invested in BP stock. I and other advisors have, to no avail, cautioned against this. Reinforcing that important lesson, the Deep Water Horizon tragedy shows that single stock concentration is dangerous. Academically, portfolio construction limits concentration in any one stock to less than 5%. Realistically, this guideline is 15% to 20%. Investors who are employed by and dependent on a company for health and retirement benefits should stay at the lower end of these ranges. Logically, if your company gets in trouble, simultaneously losing your job, health benefits, and seeing your net worth greatly diminish could be catastrophic.

But I still own BP stock, so what now? First, note that while there’s serious damage, nothing’s over. On Wednesday, Wall Street traders put a 39% probability that BP could default on its bonds – which is catastrophic for its common stock holders. I believe the primary risk with BP stock is that the company goes bankrupt or is broken up. Investors must learn their options. In this case, I actually prefer a more sophisticated option which is to buy a put option allowing investors to sell a stock at a certain price in the future. Options can be complicated, seek good advice.