It has been a while since there was any news coverage regarding BP's Mexican Gulf oil spill disaster, and the firm have settled all but $11bn of their original $41bn liability. However, penalties and fines from the US government are still an unknown factor, with some reports hinting that the final bill could be in the region of $20-25bn.

The question is, how would a settlement of this size affect BP's cashflows?  If we take the value of a company to be the sum of its discounted future cashflows, than we can arrive at a value for the potential effects of the fines fairly easily.

The market capitalisation of BP at present is roughly $150 billion, so a $20 billion penalty would be the equivalent of 13% of the firm's market capitalisation. Let's assume that the market has not yet accounted for these incoming penalties - an unrealistic scenario, but one that gives us a point to start from.

The potential hit of a greater-than-expected liability is a risk that any reasonable trader would be able to recognise. One strategy for dealing with this risk is to create a protective put position at the current strike price, in order to protect your position. At present, a put expiring in July at a strike price of 47 (ADR price) has a price of 3.25. Therefore the cost of protecting a potential BP position comes at a potential upside cost of 7%, or 4% on the stock investment.

If you think that BP is likely to settle with the US government over the next few months, but are worried about the size of the liability, then a protective put may be the best strategy for managing risk. Of course, the downside of this strategy is that any potential gains would be hampered by the cost of the option. 

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