As stated in my last article, 3 Dow Stocks to Buy-Write Now, I believe financials will outperform the market in the early part of this year. The most attractive financial stock to me is Citigroup (C). I believe Citigroup will outperform both the market and the very popular Financial Sector SPDR ETF (XLF). Below, you will see a chart from Google Finance comparing many of the largest financial stocks as well as XLF.
We can see many of the financial stocks such as Goldman Sachs (GS) and JP Morgan (JPM) lagged the Financial Sector ETF in the last year, while Wells Fargo (WFC) outperformed it by roughly 5%, and Citigroup by 38%. This isn't necessarily because the companies are better than one another, but it is normal that lower priced stocks typically outperform higher priced stocks in an uptrend and vice versa.
With that being said, and financials set to outperform, I want to own higher beta financials - therefore, I choose Citigroup. This, however, is not the only reason I would choose Citigroup. With the stock making recent highs on heavier volume, and the stock finally being able to gain the $5 per share mark, I believe this stock is setting up to have a very good year.
As you can see from the chart above, the technicals on Citigroup are quite attractive. The stock has been rallying on increasing volume. You can see the on balance volume (green dashed line) is actually leading and breaking out to new highs as well. Granted, it is a bit skewed by December 7, which happens to be the day the government sold their massive stake; the trend was still increasing before then. The stock has recently held the $5 mark, and it's obvious the stock struggled with the $5 per share mark in September 2009 and April 2010, making it significant resistance. The stock managed to close above $5 twice, and exactly at $5 once in September 2009, but never managed to close above those levels in April 2010. Citigroup will try to make Tuesday its fourth consecutive close above $5, which will likely make the previous resistance a new support level. With the hold above $5 looking more promising, it could attract much more new money because many funds won't touch stocks below $5.
In this article, I will detail an option strategy which is like owning the shares (synthetic stock option position). Normally, synthetic stock positions use the same expiration month, but I am choosing two different expirations to make up my strategy. This is simply because I think Citigroup will increase faster sooner rather than later.
As stated, I believe financials will outperform the market in the first half of this year, so I am choosing expirations no later than June. I would choose to sell or write naked put options for the Citigroup June 5 for $35 per option contract. With the money received, I would purchase March 5 Calls for $35 per contract. I could do this entire strategy for a net debit/credit of $0 plus commissions.
It is very important to note that if Citigroup closes at or below $5 per share on June options expiration, I would be obligated to purchase 100 shares for each contract I am short. If Citigroup rallies until March, I would receive $1 per contract for each penny Citigroup closes above $5 on March options expiration. The break even point would be if Citigroup closed exactly at $5 per share on both March and June expiration (extremely unlikely, but possible). As of now, Citigroup is 13 cents in the money, so assuming Citigroup closed exactly at the current market price on March expiration, and above $5 a share on June expiration, this strategy would return $13 per contract for a cost of $0. If Citigroup is significantly above $5 per share on March expiration, I would look to close the June 5 put options out just to take the remaining risk off the table.
This strategy isn't for someone not willing to take shares of Citigroup for $5, because one could have the shares put to them at anytime if the shares are trading below 5, or will have the shares put to them if the stock closes below $5 on June expiration. However, I am willing to take more shares, so this strategy fits my risk profile. I am choosing this over owning shares mainly because it gives me the shares at a discount to market, but also because it allows me to leverage my position in Citigroup.
As much as I dislike selling puts in a low volatility market, I believe selling them combined with buying calls is a good entry point in Citigroup stock.
The ideas outlined above are bullish strategies and should not be considered if you think the stock will sell off in the near future. However, if you feel the stock could move higher in the near future, this strategy could yield a nice gain.
These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.
The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio, as well as create income off of your shares (see chart here). Keep in mind when using this strategy that it is essential that broker commissions are low enough to profit from the position.