Citigroup (C) options have become very expensive in the leadup to preferred conversion July 28. Note that the gap (click on chart to enlarge) between implied volatility (now around 100%) and empirical volatility (at only 50%) is the widest in quite some time. That suggests that the arbs who hold Citi are willing to pay up for a hedge between now and the 28th, fearing that once the float increases drastically through conversion, the share price will drop sharply. That’s ineffable: we’ve never been through anything like this before, so it’s hard to guess.
This isn’t earnings-related, but conversion-related. JP Morgan (JPM) option volatility stayed subdued in the advent of earnings:
I still see Citigroup as a $4 stock (which is where I was in April). This week’s stock price crash to $2.56 probably reflected the same rush for hedges as the jump in option-implied volatility. The arbs, I surmise, have sold the rumor and will buy the news. (I own some Citi preferreds (C.P) which will convert on the 28th).
My mystical intuition tells me that Citi will beat estimates for its second-quarter results on Friday, and show better-than-expected top-line performance. It will also show a nasty loss rate on the consumer sections of its portfolio. The analyst consensus has Citi losing about $.30 a share; I think they will do a bit better. I would not be surprised to see the stock at $4 — but I would be an enthusiastic seller at that level.
With the unemployment rate elevated and rising, losses on Citi’s consumer portfolio will continue to mount, and the toxic waste coming out of its SIV’s onto its balance sheet will bleed income indefinitely. This is still a zombie bank with no real capacity to earn, and the stock price is simply the option on a possible future resurrection. For that, $4 is plenty.
Disclosure: Author has position in Citi preferreds