New Trade $C: Playing for Consolidation Prior To Q4 Earnings

by Dan January 4, 2013 3:37 pm • Commentary

Here is a quick preview of what I will be discussing tonight on Options Action on CNBC at 5pm:

Citi (C) has been up nearly 21% since Oct 15th the day that it announced better than expected Q3 results that were highlighted by better than expected revenue performance in capital markets and net interest income,  solid expense controls, higher than expected Tier 1 capital levels, and continued improvement in credit trends among customers.  The icing on the cake, came the following day when the board ousted 5 year veteran CEO Vikram Pandit in place of a long time internal manager who was perceived to be better equipped to return the bank to meaningful earnings growth and negotiate with the Feds on their quest to raise their dividend and buyback shares.

The “love-fest” continues, as just this morning, Goldman Sachs added Citi to its Conviction Buy List (replacing JPM), not just the Buy List of things that thye don’t care much about, but the one that they realllllllly believe in.   I am certainly not going to step in the way of the convicted crew at GS, and to be fair this is not a short term call, but with the stocks recent run, there appears to be a decent bit of complacency built into the options pricing in the name.

Vol Snapshot:

At the money implied vol in C options (blue line in chart below) is about 29 in Jan, which is slightly below the 30 day realized vol of 29.50 (white line), and well below the 60 day reading (orange line) of about 33.5, and making new 1 year lows.  This is not a common occurrence when you can buy at the money options below realized in front of an earnings event.

Citi at the money IV vs 30 & 60 day relaized vol from Bloomberg
Citi at the money IV vs 30 & 60 day relaized vol from Bloomberg


MY VIEW: this is by no means a story that I want to step in front of for the sake of being contrarian, the stock is still down ~80% from its all time highs in 2007, and with a new CEO in place in the midst of a massive restructuring this stock could be a buy on any meaningful pull back  in 2013.   That said, the set up into their Jan 17th earnings report seems fairly interesting with IV as reasonable as it is, the stock up 24% over the last month, a massive near term sentiment shift and the fact that Q4 results are likely to be fair at best in their core businesses. One last point about their new CEO Mike Corbat who will be holding his first quarterly earnings call where he has essentially been at the helm for the entire period.  My sense would be that the board who ruffled a few feathers to get him in his seat want to see him set up to succeed rather than disappoint in the coming quarters, and how best to do that than to set realistic, but cautiously optimistic expectations.

So from purely a trading perspective, I want to set up for a near term consolidation with the potential for a pull back post Q4 bank stock earnings that reflects decent quarters with cautiously optimistic guidance that in my opinion is already IN the stocks.  No matter what your directional bias, weekly calendars make sense, mine obviously is playing for a consolidation next week and a greater pullback the following week after earnings.

TRADE:  C ($42.34) Bought the Jan-11th / Jan-19th 41 Put Spread for .32

-Sold 1 Jan-11th 41 Put at .16

-Bought 1 Jan-19th 41 Put for .48

Break-Even on Jan-11th (next week) Expiration:

-Ideal scenario is that the stock is or slightly above 41 and the Jan11th 41 put expires worthless and I own the Jan19th 41 Put for .32, at which point I will look to sell a lower strike put in an effort to lower my break-even but also set up for an earnings move lower.

-If the stock is at or below 41 I could close the position and would make the difference btwn the option that I am long and the option that I am short.

-A dramatic move higher or lower could render the spread near worthless, but I am only risking .32

Trade Rationale:   This is a trade, I am not making a massive directional intermediate or long term bet that Citi goes lower, I am looking to use the weekly options to finance the already cheap Jan regular options that catch earnings.  I can’t argue with those who would say why fight the momentum, but my game is not buying run away break-outs at 18 month highs.

I am initiating this position at a THIRD of my normal position size now and will look to see how the stock acts next week, one of the biggest issues with putting the trade on this early before earnings is getting the strikes correct, I will reserve the right to adjust strikes next week if necessary.