Monday, April 13, 2009

The Citigroup Squeeze

Today, I highlighted Citigroup's horrendous call on the financials; but tomorrow, Citigroup will spike, as the weak shorts are getting slaughtered out on the Citi convert trade.

I wrote about that story here.

That was then:

Citi's preferreds were trading around 13, that converts into 7.3 shares of common, but the cost to borrow Citi was upwards of 100% on an annual basis, putting a squeeze on those that did the trade before it widened! Assume someone shorted C at 2 (7.3x2=14.6) and bought the preferred at 12, to lock in a couple points in the spread, and with C trading at $3.37 (7.3X3.37=24.6) in the pre-market, the trade had widened 10 points in the face of those that shorted, without a commensurate move in the preferred.

This is now.

Today Citi closed at 3.82. 3.82X7.3=27.88. Look for Citi to trade to 4.40 tomorow. Multiply that by 7.3 and you have 32.12.

Anyone that did the convert-arb at 2 (14.6) is now looking at a short position double the price when he first put it on.

Why would anyone do this convert? Why don't you ask JP Morgan? They were touting the heck out of this trade. Buy the Citi preferred which is convertible in common, and then short the common in the ratio that you get with the preferred. When the Government issues shares, you pocket the spread, and JP Morgan takes 10-20% of your profit by finding a locate of Citigroup stock for your trade.

Why did JP Morgan suggest such a sophisticated trade?

Why not?

If they would suggest to you, to just buy Citigroup when it was a buck, you could buy all the shares you wanted online for $9.95, and make 400% on your money, without JP Morgan's fatherly advice.

And then, JP Morgan, wouldn't get the juice from you, by charging you 10% a month for the Citi stock it located to facilitate your short, or the egregious commission to buy the preferred, and to short the common against it.

So let's do the math.

Buy 200,000 shares at C at $1, and pay $200,009.95 for your position.

Sell it at $4, and make a profit of $599,980, and pay all of $19.90 in commissions.

Or you could do it the JP Morgan way.

Buy 16,666 shares of Citi preferred at 12, and pay .06 a share for a cost of $201,000.

Now short 121,661 (16,666 x 7.3) shares of Citi common against your position at a price of 2, and pay .06 a share for a $7,300 commission, netting you $236,032.

Your cost to carry this short is $23,600 for the year. Assume it takes you 2 months to unwind your position, so you pay $4,720 for the stock locate for two months. Subtract that from the $236,032 you received for your Citi short and you have $231,312 from your $201,000 position, or a $30,312 profit, while JP Morgan makes $13,020 for facilitating this trade.

Why be a hedge fund, when you can book 30% of the profit on a trade? (30,312+13,020=43,332 x .30=$13,000=JP Morgan's vig!)

Except life doesn't work this way.

Once again, you have a crowded trade, blowing up in Wall Street's face!

The short on the common you have laid out, has now doubled in your face, and the preferred hasn't moved with the common.

Now you're at the mercy of your prime broker!

All because they didn't want to advertise a $9.95 trade that you could do online.

So tomorrow, Citigroup, which was Meredith Whitney's pick for the worst financial, will have put in the best rally percentage wise, of any of the big banks.

And the CIX, which is widening out, is just wiping some of these hedge funds out, who thought they had some Free Money in arb land, who are swcrambling to cover the shorts they laid out!

And I'll book another monster profit, because I just followed a very simple adage.

So the last shall be first, and the first last.
Matthew 20:16


cliff said...

still expecting a nice move in MOS this week ?

Did you see the move today in FEED at 30+ percent. That was a whopper.


Palmoni said...


There was some buying in POT, and since the fertilizers are the group that is owned the most by those who trade the materials, I think they were being held down while the material stocks were accumulated.

MOS was downgraded by JP Morgan Friday, so they have to work that off, but it's at the level where it should now move.