Comments on: Citigroup & Berkshire Anomalies

By: sluttfotodasp

sluttfotodasp — Thu, 04 Mar 2010 20:55:47 +0000

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By: Citigroup and Efficient Markets

Citigroup and Efficient Markets — Tue, 21 Jul 2009 16:36:37 +0000

[...] The Citigroup pricing anomaly may be in its final days (earlier posts here and here). [...]

By: Citigroup & Efficient Markets « Donald Marron

Citigroup & Efficient Markets « Donald Marron — Tue, 21 Jul 2009 16:02:13 +0000

[...] July 21, 2009 by Donald Marron The Citigroup pricing anomaly may be in its final days (earlier posts here and here). [...]

By: The Citigroup Repo « Donald Marron

The Citigroup Repo « Donald Marron — Fri, 10 Jul 2009 16:02:56 +0000

[...] 10, 2009 by Donald Marron As I’ve noted in a series of posts (here’s the most recent), there’s an anomaly in the pricing of Citigroup securities. Several issues of Citi’s [...]

By: chappy

chappy — Tue, 07 Jul 2009 19:24:55 +0000

Thanks!

Per your answer in 1: Doesn’t this imply that the price of the stock is going up if the call buyer is immediately exercising the option? If it is so obvious that this is the prevailing wisdom, why don’t they just buy the stock itself and cut out your premium? Does this mean that the call buyer thinks that the price is going up, but the perceived volatility of the (common) stock makes it worth the premium?

Anyway, thanks much for your helpful answers.

By: Donald Marron

Donald Marron — Tue, 07 Jul 2009 16:18:13 +0000

Good questions. I will probably cover these more fully in a future blog post, but here’s the gist of what I learned in my research (I don’t find these surprising, by the way, but I wanted to see if reality tracked theory):

1. On paper, the best way to simulate a short position in the common would seem to be to write (i.e., short sell) a deep-in-the-money call, which is effectively a share of stock. Of course, everyone else has already figured this out. In this case, that translates into the following scenario: you write the option and then wake up to discover it’s been exercised the next morning (darn American options).

2. The next best is to write a distant near-the-money option. You pocket the premium, but you have to bear the basis risk — i.e., the option not tracking the stock price. You also have to deal with the changing delta — i.e., the quality of hedge changes as the underlying stock price changes. In this case, as the price of C has fallen, the quality of the hedge has weakened. I’ve been too lazy to short more options, so that means I’ve fallen behind on the deteriorating quality of the hedge.

By: chappy

chappy — Tue, 07 Jul 2009 14:59:03 +0000

Oops. Sorry I should have noticed that difference. Is this actually a better hedged position? If you actually shorted the stock your downside risk is that the ‘spread’ reverses, correct? With a call option you are under no obligation to buy at your agreed strike price, but I guess you are out the premium you pay for the option? I’m just trying to figure out how the two different methods functionally differ in terms of your costs/risks.

By: Donald Marron

Donald Marron — Mon, 06 Jul 2009 21:20:12 +0000

Hi Chappy — I would have loved to be short the common if I could find a way to do that cheaply enough. Unfortunately, I couldn’t, so I am short some call options on the common, not the common itself. Some readers have told me they’ve gotten short the common in various ways but it’s either (a) expensive or (b) temporary, with the short shares being called back with some frequency.

By: chappy

chappy — Mon, 06 Jul 2009 20:56:03 +0000

Interesting update. You say that it may be difficult to short the common stock, but yet you yourself claim to have shorted it yourself. Are you claiming that an institutional investor would have a difficult time shorting a larger position?