The Citibank Arbitrage: Extreme Number of Options Traded

The upcoming conversion of preferred Citibank shares for common shares is causing a very significant surge in the number of options traded in the stock. Take a look at the positions, volumes and open interest, as of EOD Friday, the numbers are absolutely huge:

April:


(please click on images to enlarge)


May:




June:



September:





The trade in C shares has been very popular because the conversion can yield big profits. The bank said on Friday it is not changing terms of a preferred share exchange. The actual conversion process is explained in this page.

A popular trade that locks in profits involves buying Citi preferred stock and simultaneously selling borrowed shares of common stock (shorting). The preferred shares can be converted into common stock in a few weeks, and so can be used to buy Citigroup shares at a lower price than the level at which they are trading now. Because the trade is so popular, it has become very difficult or expensive to short the stock. Traders and then resorting to

"synthetic puts",

which is the practice of buying and selling options to simulate being short on the stock (for example, buying puts and selling calls). Hence, the very high number of options traded.

$52.5 billon of preferred shares for common shares sould be converted. Under the exchange offer terms announced in February, preferreds will buy Citigroup shares at $3.25 each. C shares closed Friday at $3.65.

"Analysts Venu Krishna and Maneesh Deshpande at Barclays Capital on Friday said value investors could simply buy Citi convertible preferred stock series T, which traded for about $34.25 on Friday. When the exchange offer goes through, a $34.25 preferred share will convert into roughly 13.08 Citi shares now worth about $47.73. In other words, $34.25 of preferreds can buy $47.73 worth of common stock. "

The arbitrage play has caused a spike on the price of C, part of it as a short squeeze, clearly seen on the stock price chart: