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Here's why traders are placing bullish bets on BP

Rumor of Shell bid drives BP shares higher

BP's stock is rising on a recurring rumor that Royal Dutch Shell is set to bid on the company. And some options traders are betting the oil giant's stock is set to rise much more by the end of the week.

Short-term options on Shell were extremely hot Tuesday morning, with bullish call options expiring on Friday dominating trading. Thousands of weekly 40-strike calls, 40.5-strike calls, 41-strike calls, and 41.5-strike calls were purchased, for share prices ranging from about 25 cents to $2.

Both BP and Shell had no comment on the rumors.

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The short-term nature of the trades indicates that while traders weren't willing to make long-term bets on the future of BP, options traders will willing to purchase low-priced options in order to potentially capitalize on more bullish news about the oil company through the rest of the week.

In the first three hours of trading, BP calls had already traded nearly four times their average daily volume.

Interestingly, the weekly 40-strike calls on BP were also well-bought on Monday, with 3,278 contracts changing hands, most of that volume coming 10 minutes before closing. In fact, 848 contracts were purchased in a single block. While it is impossible to know the impetus behind the buying, the traders who bought those contracts for 38 cents nearly tripled their money overnight.

Options expert Mike Khouw said upside call buying has been the most popular type trade in BP options since Nov. 25, which is somewhat unusual. In addition, four of the five most bullish trading days in the last 22 have occurred within the past week.

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"There has been steady and building interest in the kinds of bullish bets we're seeing in larger size today, which is consistent with this rumor getting around slowly," he said.

Shares of Royal Dutch Shell also rose on the rumor, though U.S. options trading on the Shell ADR is thin.

Over the past five months, BP shares have lost about a quarter of their value as oil prices have slid. This loss of value could potentially make an acquisition at current levels more attractive. Last month, Halliburton agreed to buy Baker Hughes in a $34.6 billion deal.

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For Dan Nathan of RiskReversal.com, buying weekly at-the-money options is a smart way to play a situation like this.

"Traders hear rumors all day long, but BP is interesting. We have seen a deal in the oil patch. We know that some of these guys are inclined to consolidate. We know the stock is oversold. So playing with weekly calls if you hear a rumor like that makes some sense."

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