Options Update: Straddling Citigroup

              

Options traders are hot on the heels of financial giant Citigroup (C: sentiment, chart, options), with investors trying to take advantage of the stock's more than 200% rally from its early March lows. Still, the company's troubles, and the ongoing financial crisis, have the equity trading 55% lower compared to the start of 2009. Furthermore, C has plummeted more than 87% during the past 52 weeks.

This poor technical backdrop is far from inspiring for bullish investors, but the heavy losses don't appear to have deterred options speculators. Specifically, C's Schaeffer's put/call open interest ratio (SOIR), which measures put open interest against call open interest for the front 3 months of options, arrives at 0.68, indicating that calls easily outnumber puts among near-term options. This ratio also ranks below 73% of all those taken in the past year, meaning that investors have been more bullish toward C only 27% of the time in the prior 52 weeks.

This bullish options configuration is supported by data from the International Securities Exchange and Chicago Board Options Exchange. Currently, the ISE/CBOE 10-day call/put volume ratio arrives at 2.28, meaning that calls bought to open have more than doubled puts purchased on these exchanges during the prior 2 weeks. This ratio arrives higher than 81% of all those taken in the previous 12 months, underscoring the rising preference for purchased C call options.

In today's trading, more than 140,000 calls have traded on C so far, easily tripling the stock's daily average and placing the shares on our Intraday Volume Explosion List. More than half of this activity has changed hands at C's out-of-the-money June 5 call. Additionally, practically all of this volume traded at the ask price, and was labeled "spread."

After a little digging, I discovered that the other half of a majority of these "spreads" traded on C's June 5 put, also at the ask price. This activity suggests that traders could be opening straddle positions on the equity. While this is the theme that I am running with as today's trading example, there are a wealth of other possible trading strategies that could also explain the activity, especially considering the extremely heavy call and put volume levied against Citi in the options pits today.

Anatomy of a Citigroup Straddle Position

For reference, a straddle is the simultaneous purchase or sale of an equal number of puts and calls on a given underlying stock with the same expiration date and strike prices. Looking at the chart above, you can see that several large blocks of June 5 calls and puts changed hands at about 11:10 a.m. Eastern time, all at the ask price. Assuming these trades were all part of a larger position, the resulting straddle trade would break down as follows.

First, the trader buys 5,750 C June 5 puts at $2.57, for a total outlay of $1,477,750 -- ($2.57 * 100)*5,750 = $1,477,750. At the same time, the trader buys 5,750 C June 5 calls at $0.25, for a total cost of $143,750 -- ($0.25 * 100)*5,750 = $143,750. The total price tag on the position arrives at hefty $1,621,500. The idea behind this strategy is for C to move sharply -- the direction doesn't matter, though with the call so far out of the money, this position appears to have a bearish slant -- before the options expire on June 19.

For the trade to reach breakeven, C must either rally about 159% to $7.82 per share, or fall nearly 28% to about $2.18 per share. To arrive at our breakeven target, we add the cost of both options ($2.57 + $0.25 = $2.82) and add/subtract that total to the purchased strikes. For instance, on the call side, we add $2.82 to purchased June 5 call ($5.00 + $2.82 = $7.82). On the put side, we'd subtract $2.82 from purchased June 5 put ($5.00 - $2.82 = $2.18).

Clearly, the trader would need a sizable move from C in order to turn a profit on this trading strategy. It is the combination of the shear size of the necessary move with the extremely heavy option volume on the equity today that raises my suspicions that I am not seeing the entire trade. Still, there has been enough volatility in the financial sector in 2009 to justify a June 5 straddle on C. All the company needs is more proof that it has turned profitable, or more evidence that it has yet to fully put its troubles in the past. Putting these unknowns aside, let's see if C's technical and sentiment backdrops provide any potential drivers for this trade.

Checking the Charts

As mentioned above, Citigroup's recent surge higher from its March lows remains overshadowed by the equity's long-term decline. While C has turned skyward along the support of its 10-day and 20-day moving averages, the equity's descending 20-week trendline, which resides just below the 5 level, remains a major technical hurdle. The shares have logged only 2 weekly closes above this intermediate-term moving average since June 2007. What's more, the security must first tackle support/resistance at the 3.50 level before it can even challenge this trendline. The 3.50 area provided support for C in November 2008 and throughout much of early February, but now appears to have switched roles, holding the shares in check for the past several weeks.

The Sentiment Drivers

While speculative traders have clearly expressed a preference for bullishly oriented calls, investor optimism disappears once you leave the options pits. For instance, the number of C shares sold short jumped by nearly 12% during the most recent reporting period, resulting in about 3.7% of the stock's float being sold short. While this is far from an extreme degree of short interest, a continuation of this trend could provide additional selling pressure for C.

Meanwhile, all 9 analysts following the banking giant have issued a "hold" or worse rating, according to Zacks. Additionally, Thomson Reuters reports that the average 12-month price target for C rests at $3.32 per share - a 20% premium to the stock's current trading range near $2.77 per share. Both configurations provide room for the situation to deteriorate further, with downgrades or price-target cuts potentially providing additional selling pressure for the security.

The Verdict? Personally, I would be hard pressed to find an options trading strategy that I liked when it comes to Citigroup. I would certainly not be fond of a straddle position at the June 5 strike. If I were to implement a straddle on the shares, I would probably focus on the at-the-money April 3 strike.

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