Buy C Call Options: Closing Citigroup’s Huge Valuation Gap

It is a great Friday morning and I excited (for want of a better word) about the possibilities in the U.S. market as this trading week ends. The S&P 500 provides a splendid representation of what is obtainable in U.S. stocks as the index stops dawdling around 2,050 to make a new all-time high at 2,071.46 today.

It is on this bullish note that we will explore possibilities in the options of Citigroup Inc. (NYSE:C). Citigroup with its market capitalization of $164.38B is a global diversified financial services holding company whose businesses provide consumers, corporations, governments and institutions with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, securities brokerage, transaction services and wealth management.

Citigroup’s Huge Valuation Gap

C Book Value

The chart above plots the share price of Citigroup and the book value (as auto-calculated with fixed variables) within the last one year. You will observe that shares of Citigroup are trading at a 23.59% discount at the current $54.30 trading price to a book value of $67.11 per share. Interestingly, analysts at Merrill Lynch compute the book value of Citigroup at $74 per share; hence, the stock might be effectively trading at a 36.27% discount to the book value.

Interestingly, shares of Citigroup are trading at a 1.80% discount to the 52-Week high of $55.28, which suggests that the stock might be moving towards breaking out above the 52-Week high towards its real book value.

Shares of Citigroup are over-capitalized as explained above and the stock cannot appreciate to its real value if it cannot return capital to its shareholders in the form of buybacks and dividend increases. Hence, 2015 is shaping up to be a cardinal year for Citi as the company tries to buy back its shares.

Why Citigroup is Set to Close the Valuation Gap

Citi cannot undergo on a share buyback program unless it scales through the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) process. Interestingly, Citi has been applying (and failing) at the CCAR for the last three year to the dismay of shareholders and management.

In 2012, Citigroup was slammed in the CCAR on a quantitative basis in a hypothetical severe stress test scenario, which suggests that Citi is not strong enough to withstand another financial crisis on its own. In 2013, Citi was more concerned with scaling the hurdles presented by the quantitative test and the company requested a measly $1.2B is share buyback. In 2014, Citi failed on a qualitative basis even though it applied for a rather conservative share buyback of $6.4B and a raising of the quarterly dividend to $0.05.

The possibility that Citi might pass the CCAR next year is very high, considering the fact that the company now has a stronger balance sheet with a solid cash flow position. In addition, the company has reviewed its exposure to risk such that it has exited some emerging markets while planning to divest its Index business.

How to Trade C Options

If Citibank should pass the CCAR early next year (as it probably will), options traders can expect to see an upside potential between 23.59% (at a $67.11 book value) and 36.27% (at a $74 book value). Hence, the smartest move is to buy C call options. The C Jan 2015 55.000 call (C150117C00055000) is hot at an asking price of $1.25 and this is where you should put your money.

— Daily Option Alerts

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