An Option Traders Case Against Citi

I first came across Citigroup (NYSE: C) stock in the fall of 2007 on the set of Fox Business. There was an unspeakably animated, intelligent and well-informed woman in the makeup room discussing how the company was in tough shape and the stock would fall. I had been telling subscribers to short the regional banks and home builders for most of the year — they made a killing — but I had shied away from the big banks. This woman’s information and obvious skills convinced me otherwise before we got to the set.

When we got there, I Iearned her name — Meredith Whitney. She was unknown then but is now the leading bank analyst in the world. She had recommended selling the stock the week before, saying Citi would have to cut its dividend, and her life had been threatened.

I did the research and told my subs to buy Citi put options. It was my first bearish position among the big banks before the crash, with C around $40-$43 if I remember correctly. It is around $44 right now — after a 10-for-one reverse stock split a couple of days ago — meaning the stock is down 90% from pre-crash levels. And Citi is still overvalued, selling at a premium to the banking segment, with a P/E of 14.4, while the segment is at 12.

citiI’ll cut to the chase and offer an option trading idea. For Citi — take a look at out-of-the-money puts that expire after the next earnings report that is due around July 18.

Now let’s consider some more reasons why put options are the right way to trade Citi.

Banks are often valued based on their book value, but how can you value a bank — and not just Citigroup — with hundreds of billions of dollars worth of off-the-balance sheet assets? Especially when the accounting rules needed to properly mark their loans to market have been suspended for a couple of years.

I believe whatever book value analysts come up with for Citi will be too high for those reasons — and the price to book right now is $.76. Yes, Citi’s valuation to book value is below that of JPMorgan Chase (NYSE: JPM) with a price to book of $1.06 and Wells Fargo (NYSE: WFC) with a price to book of $1.27.  Wells’ book value is ridiculous by the way but it’s ahead of Bank of America (NYSE: BAC) with a price to book of $.58.

As for Citi, to quote what I told my subs, “The bank, in my view, is a mess.” Citi has little real earnings growth in its future, business has been stagnant or declining in key areas for the past two quarters and it has been understating loan loss reserves to boost profits. The company will have to book more loan loss reserves in the coming quarters, further hitting profits, making Citi an ideal long term short.

Some ask whether the reverse split will help the bank. I don’t think so.

James Rosenfeld of Emory University and April Klein of New York University recently studied 1,600 companies they identified that had conducted reverse stock splits during a three-year span.  In that time period these stocks underperformed others in their segments by roughly 50 percentage points. Insurer AIG (NYSE: AIG) did a reverse split last year. It went way up but is down 39% this year.

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