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The strategy of selling a put to purchase calls not only provides an investor with the opportunity to leverage a position in Citigroup (NYSE:C), but it also provides one with the opportunity of getting into a stock at a much lower price. Only employ this strategy if you are bullish on the prospects of this stock, as there is a chance that the shares could be put to your account. If you are not bullish on the stock, then it would be in your best interest to look for alternative plays.

Suggested Strategy for Citigroup

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Shares tested the $24.40-$24.61 range twice in the past seven months and, on both occasions, reversed course almost immediately. The stock also broke out very nicely past $28, a former zone of resistance, now turned into support. After breaking past $28, it trended sideways for a few days at or near the line of support. This is bullish because it suggests that the stock is building strength for the next leg up. Today's move up could mark the beginning of the next leg. A weekly close above $30 will indicate that there is a pretty good chance it is going to test the $35-$36 range before pulling back.

This play has two parts to it. The first part entails selling a put, and in the second part calls are purchased with the proceeds from Part 1.

Part 1

The January 2013 27.00 puts are trading in the $1.61-$1.64 range. The stock should test the $28.50-$28.70 range again before trending higher. A pullback to $28.50-$28.70 should push these puts to trade in the $1.90-$2.00. We will assume that the puts can be sold at $1.90 or better. For each contract sold, $190 will be deposited into your account. The proceeds from the sales of the puts will be used to complete the second part of the trade.

Part 2

The December 2012 36 calls are trading in the $0.56-$0.58 range. If the stock pulls back to the stated range, the calls should drop down to the $0.40-$0.44 range. We will assume that each call can be bought for $0.44 or better. For each put sold, you will be able to purchase up to four calls and still have a net credit of $14.00. If you are bullish on the stock at the current price, then you could put the strategy to use immediately.

Benefits of This Strategy

You have an opportunity to significantly leverage your position in this stock for a relatively low cost. To secure the put, an investor would have to put up $2,700 but he or she would be in a position to control up to 400 shares. If you had to purchase 400 shares at the current price, you would have to put up roughly $12,000.

If the stock trades below the strike price you sold the puts at, the shares could be put to your account (assignment usually occurs on the last trading day of the option). Depending on the number of calls you purchased, your cost per share could range from $25.54 (if you purchased one call only) to $26.86 (if you purchased four calls).

The Potential Risk

If you are bullish on the stock, the only risk you assume is that the stock might be trading at a lower price when the shares are put into your account. This is the same risk you take when you purchase the stock outright. One way to deal with this is to simply roll the put if the stock is trading well below the strike price. To do this, you buy back the put you sold and sell new out of the money puts.

Conclusion

To initiate this strategy you need to be bullish on the longer-term prospects of Citigroup. Do not put this play into effect just because it sounds enticing, as there is a chance that the shares could be put to your account. This strategy provides those who are bullish with the chance to significantly leverage their position without incurring a large cost.

Note: EPS, company vs. industry, and price vs. industry charts obtained from Zacks. A major portion of the historical/research data used in this article was obtained from Zacks. Options tables sourced from Yahoo Finance.

Disclaimer: It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies -- let the buyer beware. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: A Simple, Low-Cost Strategy To Significantly Leverage A Position In Citigroup