Citibank's Upcoming Reverse Split

This week marks the final days that Citibank will be trading below $5 per share (or even $20 per share) for some time!  This is not due to the business getting remarkably better and the prospects for the shares becoming suddenly bullish.

Rather, the company will be going through what is known as a reverse split of their shares.  The previously announced 10-for-1 reverse split will  take place this weekend with the shares trading ex-this split Monday morning.  What this means for the typical investor is if they held 1,000 shares of C stock, on Monday morning they will have only a 100-share position.

Investors are not economically disadvantaged as the stock's trading price will likely be around $45.20, up from the current $4.52 due to the fact that the company is the same size but there are 1/10^th the number of shares outstanding.

For Citibank option holders, the strikes and positions will be unchanged.  The Option Clearing Corp. (the OCC) will simply change the deliverable for the exercise and assignment of the options.  One contract will deliver 10 shares of C stock rather than 100 shares.  For example, if you currently hold long a single contract of the 4-strike calls expiring in May, the  delivery will be 100 shares of C stock for an exercise price of 400 dollars ( 4 X 100= $400).

Example:

If exercised before Monday, the value would be 4 (the strike) times the multiplier (100) for one contract's worth of the deliverable, or simply 100 shares of a $4.50 stock.  You would pay $400 for a resulting 100-share position worth $450 (with the stock trading at $4.50).  After Monday, if exercised, you would pay 4 (the strike) times the multiplier of 100 for one contract worth of the deliverable, which is now 10 shares of a $45 stock.  Your net cost is still $400 and the resulting 10-share stock position is still worth $450. The multiplier is still 100, but the concrete deliverable (in share terms) is one-tenth of what it is pre-split.

Additionally – and this is is very important for OptionsHouse customers – your current positions will appear on the option chain only if you select the “Non-Standard Deliverables Options” box within the Manage Accounts Tab.

This reverse split is the opposite of a normal stock split.  A company typically performs regular splits when their shares have appreciated to a price at which the average investor can no longer afford to own them.  They used to be very common.  In the ‘90s, Amazon.com (AMZN) split its shares three times.   Apple (AAPL) did it twice, early last decade.  Google (GOOG) has reversed this trend by not splitting its stock, regardless of the lofty share price.  Warren Buffett is famous for lambasting companies that split shares as a way to use “smoke and mirrors” to try and make the company seem “cheaper” and therefore more appealing to investors.

A reverse split certainly will have an effect on the number of shares trading in C daily.  Investors will only have to trade 1/10 the number of shares to have the same dollar exposure to the stock.  Also, many mutual funds that possibly have rules forbidding the holding of shares less than $5 may be able to now purchase and hold this stock once again.

But to me, the biggest benefit of this corporate action is that the bid/ask spread for both the stock and the options will likely narrow as a percent of the notional value.  Currently the bid/ask spread is one penny for many of the options.  Now instead of trading the 4.5 calls in May which are currently bid 0.10, asked 0.11, traders will be able to trade the 45 calls.  I am pretty confident the bid/ask prices on the new strike will be tighter than 1.00/1.10.

High-Frequency traders will bemoan the point that there will not be 15,000 contracts on both sides of the market anymore.  I see two problems with that logic:

1. Did you really need 15,000 contracts of liquidity?
2. A one-cent wide spread on a 10-cent option premium is a 10% wide bid ask spread (measured on premium).

If post-split $45 C options exhibit the same one-penny bid/ask spread that JPM options do, this spread is only 1% wide in terms of premium. I think this is ultimately good for retail traders.  I wonder if Warren B. is applauding this move by Citi?

Photo Credit: Christina

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