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Citigroup Goes Tilt?


A squeeze is clearly afoot in the bank's stock.

This Citigroup (C) preferred vs. common arb has gone on tilt again.

Arbs buy the C preferred vs. shorting C common. Except he can't do it at the same price as C is trading as there are huge and variable carry charges on the short stock. So they frequently play it with the options. Specifically, the June 5 reverse/conversion.

Someone wanting to short C can instead buy C June 5 puts and short June 5 calls to replicate a stock short. Right now, the June 5 line (really all the June lines if the puts are ITM) trades at about a 90 cent discount to C stock. So in other words, with C trading $4.40, you can effectively only short it at $3.50.

Zero Hedge has run this chart the last few days. Basically, the higher that number goes, the more pain is felt by the arbs as the short stock has squeezed up.

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Now the concept is correct, but not sure about the actual numbers as I'm assuming Zero Hedge picks up the C stock as the short side of the play. But if, instead of shorting C stock and paying the big charge, you just have the conversion on at a discount, C is effectively only trading at $3.50, not $4.40, as we showed above.

And plenty of people are doing that, as the open interest is an unreal 1.653 million in the calls and 1.498 million in the puts. Of course, if you had this on in the options, you put it on at unfavorable prices to begin with, albeit not this unfavorable as now as the discount was only $0.30 to $0.40 last week.

But that's all relatively minor quibbling. Bottom line, there's a clear arb squeeze going on in C.

And here's some more to watch for if it keeps going.

Arbs have to use strikes with ITM puts, lest they risk assignment on short calls. And they will (or should) get assigned calls once the calls get reasonably in the money thanks to the monstrous stock borrowing costs. So what happens if C shoots up to the mid 6's?

Well, the shorts on the June 5 line now may get assigned some or all of their calls. Which leaves them short physical stock vs. the preferred, but now also naked long all those puts. Which all rolled up gets them pretty short overall and even more likely to squeeze it ever higher.

Now the preferred should convert before any of that comes to pass. But just in case it doesn't, for some reason, look out.

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