Citigroup Inc (C)

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Bearish Traders Target Citigroup (C) But Should Retail Investors Follow Along?
By: Barchart | October 11, 2022

By arguably most measures, retail investors should avoid acquiring share of Citigroup (C) despite its significant discount in the market this year. While one of the largest financial institutions in the world, the incoming wave of macroeconomic headwinds don’t necessarily bode well for bellwether plays like C stock. Nevertheless, a small window of opportunity for contrarian traders exists.

First, the bad news. Since the start of 2022, circumstances quickly confirmed that soaring inflation – if left to its own devices – would unwind whatever good the Washington machinery implemented in saving the U.S. economy from the ravages of the COVID-19 pandemic. In large part to unprecedented monetary and fiscal stimulus programs, the money supply expanded rapidly. Now, the Federal Reserve had the unenviable task of dealing with prior excesses.

Throughout this year, the central bank pivoted to a hawkish monetary policy, consistently raising the benchmark interest rate by a hearty 0.75%. What’s more, statements delivered by Fed chair Jerome Powell indicated that he viewed inflation as a primary threat to future economic stability. Therefore, the Fed is willing to accept some pain in the near term to avoid catastrophe over the long run.

Unfortunately, the hawkish strategy is easier said than done. When the September jobs report came out, economists were taken by surprise as employment figures exceeded expectations. Generally speaking, a strong labor market is desirable as it implies a robust economy. At the same time, this circumstance also translates to more dollars chasing after fewer goods, creating the very inflation that the Fed is desperately trying to tame.

Therefore, folks on Wall Street anticipate that the central bank will become even more aggressive with its monetary tightening strategy. While this dynamic theoretically bolsters C stock through greater profitability in lending programs, the harsh reality is that if the Fed overcooks the tightening measures, it could lead to a recession.

Of course, that would be deflationary and unhelpful for C stock. Thus, it’s not terribly shocking that Citigroup became the subject of bearish unusual options activity.

Pessimists Attempt to Advantage C Stock

Following the closing bell of the Oct. 10 session, bearish traders moved in on the $37 put options for C stock. Puts rise in value as the underlying security declines in the open market. In this case, the targeted order features an expiration date of Oct. 21, 2022. Volume reached 5,422 contracts against an open interest reading of 118.

Moreover, the bid-ask spread as represented by the midpoint price (33 cents) came out to 6.06%. While not horrifyingly wide, it’s not exactly narrow either. Typically, wider spreads indicate lower liquidity levels. In addition, market makers often give themselves a healthy margin for transactions that are difficult to place.

For the record, C stock closed at $41.60 in the open market on Oct. 10. Therefore, shares will need to decline by a hair more than 11% to be at the money. With only 10 days to expiration since the placing of the trade, this is an aggressive wager.

Another factor regarding the unusual options activity for C stock that won’t shock anyone is that it aligns with the predominant trend in the derivatives market. According to data from Barchart.com, Citigroup features a put/call open interest ratio of 1.10. Under normal market conditions, the threshold separating bullish and bearish sentiment is around 0.70.

Since the numerator represents the number of puts being acquired, an open interest ratio greater than 0.70 signifies bearish sentiment (i.e. traders are buying more puts than calls).

If that wasn’t enough to convince you to abandon ship on C stock, analysts are pensive on the underlying company. True, the consensus rating is “moderate buy.” However, with 60% of Wall Street experts rating Citigroup a “hold,” it’s not the most convincing consensus assessment.

The Small Window of Bullishness

Although the incoming monetary wave suggests that deflation may eventually become the dominant trend, contrarian investors may still want to consider C stock as an upside opportunity. To be clear, the overall framework for Citigroup – and the financial industry as a whole – remains negative. However, deflationary forces can allow Citigroup’s wealth management business to shine.

To understand why, investors must appreciate the economic incentive under an inflationary cycle. With the dollar steadily losing purchasing power, investors face two fundamental choices: spend the money or invest it. If they sit on cash, the value of their holdings will gradually erode. That’s why risk-on assets tend to move northward when inflationary forces dominate – investors must do something with their money or lose out.

However, deflationary forces impose the opposite scenario. In this case, investors enjoy an incentive to sit on cash. Effectively, this (in)action yields a risk-free positive return. Therefore, any investment opportunity must be so compelling as to convince people to step away from those risk-free returns.

Now, regular folks may not have the acumen to advertise such compelling investments during deflationary cycles. But the army of experts that Citigroup deploys could. At least, they have the opportunity to distinguish themselves, guiding clients to higher ground during a particularly troubling period.

A Tough Call Either Way

Fundamentally, the bearishness toward C stock is understandable. Economic activity appears to be slowing recently while prices remain stubbornly elevated. Thus, the Fed might see this juncture as the last chance to mitigate inflation. Unfortunately, monetary tightening would likely lead to a recession, hurting broader economic activity.

Still, people need wealth management services irrespective of the underlying monetary cycle. Therefore, C stock has a chance of moving higher on the contrarian trade. But no matter what, the transaction will require nerves of steel.

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