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Short of the Week: Citigroup (C)

Citi is the worst of the big U.S. banks


Most major U.S. banks are insolvent or perilously close to it based on 2007 pre-financial meltdown accounting standards. Insolvency does not mean they are out of cash — it means their assets have too little capital underneath them.

The banks may look OK on paper, but that is only because regulators have abandoned mark-to-market accounting rules, changed the rules on revaluing loans on commercial real estate, ignored trillions in off-balance-sheet assets and performed other tricks to prop up the banks given the unwillingness of the government to provide the lords of finance with more dough.

When the government was doling out money, the biggest recipient of this largesse was Citigroup Inc. (NYSE: C). You and I, your relatives and friends, and the homeless guy on the street — all U.S. citizens — own shares of the bank. And despite all the money thrown at Citi, it has been painfully slow in disposing of assets. Simply put, and without dwelling too much on their horrible balance sheet, ambiguous earnings statements and off-balance-sheet obligations, it is the worst of the big U.S. banks. And I think traders would be wise to look at buying some put options.

Citi is not going to fail, and customer service levels have not fallen. The issue is that the bank is heavily reliant on the consumer — loans, credit cards and so on — and we are facing a double-dip recession. Forget the company’s calculations of their own capital. Its dodgy off-balance-sheet assets and shortage of loan loss reserves are a good enough reason to buy puts in my book.

I began recommending that my Short-Side Trader subscribers short Citi around $40, after I spent a few minutes with Meredith Whitney. Obviously, the big fall has already occurred, but the opportunity for nimble traders to short the stock has not passed.

The stock is now trading in a range of $3.25 to $4.10, and this may be the most easily defined trading range you can find. Why? Uncle Sam bought at $3.25 and sold their first chunk at $4.10. If the stock nears that high point, Uncle same will dump more, depressing the price. If it gets below that $3.25 entry point, traders know Uncle Sam will refrain from dumping shares, and that will boost the stock and the options.

So that’s the play: Lousy fundamentals in weakening sector and an easily defined trading range say short Citigroup when it nears $4.10 and exit before it gets to $3.25.

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