An Investment While Citigroup Treads Water

| About: Citigroup Inc. (C)

Global financial services company Citigroup (C) is celebrating its 200th anniversary this year. The company has 200 million customer accounts in 160 countries. After recently being dealt a downgrade by Moody's (MCO), Citigroup indicated its strong disagreement with the downgrade.

In addition to Citigroup, Moody's downgraded Bank of America (BAC), Morgan Stanley (MS), JPMorgan Chase (JPM), Goldman Sachs (GS), Credit Suisse , Deutche Bank (DB), UBS (UBS), HSBC (HBC), Barclays (BCS), BNP Paribas, Credit Agricole, Societe Generale, Royal Bank of Canada (RY) and the Royal Bank of Scotland (RBS). Bank of America was discussed in this recent article and JPMorgan was covered in this article.

In its response to the Moody downgrade, the company blasted the downgrade as "arbitrary and completely unwarranted." The company noted its improvement in areas related to risk management, capital levels and liquidity as arguments against the downgrade. The company also noted that since Moody's had previously telegraphed the downgrade, the negative consequences related to the downgrade have already been compensated for by the market, and as a result, the impact from the downgrade will be immaterial. The company also indicated Moody has ignored the actions by legislators, regulators and financial firms related to enhancing the stability and resilience of the financial system.

In Citigroup's Q1 2012 earnings call held on April 16, 2012, the company reported revenue growth in all three of its core businesses: Global Consumer Banking, Securities and Banking and Transaction Services. Global Consumer Banking increased 5% year-over-year to $10 billion. Transaction Services reported record revenue of $2.7 billion and Securities and Banking revenue rebounded, driven by strong performance in the fixed income area. The company noted its capital and liquidity are amongst the strongest in the banking industry. On a negative note, the company's revenues were down 2% versus the prior year, is tentative with regard to the current macroeconomic environment and does not expect to see sustained positive operating results for North America until the end of the year.

Citigroup's stock price has dropped significantly over the last year and is currently near its previous support level in the $24-25 range as shown below:

The company has a very attractive Price-to-Earnings (P/E) ratio of 7 and an attractive Price-to-Sales (P/S) ratio of 1.2, but with its muted outlook, the price of the company's stock will probably tread water until the macroeconomic environment improves and its North American performance improves.

With Cititgroup's stock price probably treading water for a few months and the scheduled release of its Q2 earnings on Jul 16, 2012, an investor in the company might consider entering a protected covered call or collar, as the protected covered provides positioning for a potential return, even if the stock price remains stagnant, and provides for protection in case the company reports bad news. A protected covered call may be entered by selling a call option against an existing or purchased stock, and using some of the proceeds from selling the call option to purchase a put option for protection. The put option operates as "stock insurance" in case the stock price drops significantly. The nice thing about the protected covered call is the insurance is paid for via the sale of the call option, and the remaining proceeds from selling the call option operates to provide a potential return, even if the price stock remains unchanged.

Using PowerOptions tools, a number of protected covered call positions were found and are available as shown below:

The highest returning protected covered call position looks attractive with a potential return of 2.9% (26% annualized) and a maximum potential loss of 5%, so even if the price of the stock goes to zero, the maximum potential loss which can be realized is 5%. The specific call option to sell is the 2012 Aug 26 at $1.45 and the put option to purchase is the 2012 Aug 24 at $0.67.

1st Trade

  • Citigroup stock (existing or purchased)
  • Sell 2012 Aug 26 Call at $1.45
  • Buy 2012 Aug 24 Put at $0.67

A profit/loss graph for one contract of the Citigroup protected covered call is shown below:

For a stock price below the $24 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increases to $30, the position can most likely be rolled in order to realize additional potential return.

Additionally, the second highest potential returning position in the table above is attractive with a potential return of 2.3% (70% annualized) and a maximum potential loss of 5.5%. The net potential return of 2.3% is less than the first position, but the annualized potential return of 70% is significantly higher. Also, the maximum potential loss of 5.5% is slightly higher than the first position. To enter this position, the call option to sell against the stock is the 2012 Jul 26 at $0.84 and the put option to purchase is the 2012 Jul 24 at $0.20.

2nd Trade

  • Citigroup stock (existing or purchased)
  • Sell 2012 Jul 26 Call at $0.84
  • Buy 2012 Jul 24 Put at $0.20

A profit/loss graph for one contract of this position is similar to the other position, as the positions have the same strike prices (but different months of expiration).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.