Citigroup (C): Cramer’s “favorite speculation” stock

Citibank (C) option strategies Jim Cramer sounded the bullish horn on Citigroup C Tuesday night, telling his Mad Money viewers that the beleaguered banking name is “the most undervalued bank in America.” The CNBC host also said Citi “remains my favorite speculation [stock].” Cramer did add the caveat that investors will need to be patient, as the stock probably won’t really begin to show strength until the U.S. government is finished selling off its C shares.

C shares haven’t traded above $10 since November 2008 (amid the financial market meltdown) and have barely peeked above the $5 level since January 2009. The company is still keeping afloat, however; its last two earnings reports have been profitable. What’s more, Citi’s mid-July earnings report topped expectations by four cents, or 80%.

We have outlined two option strategies below, one for investors who are in Cramer’s bullish camp and one for those who expect Citigroup’s range-bound price action to continue. For the bulls, we have a long-term call and for the bears, a put ratio spread.

These are not trading recommendations, merely examples of different strategies for educational purposes. The prices are taken as of Wednesday afternoon, when C shares were trading at $3.68, down three cents on the day. For a full dissection of the strategies including profit/loss information, continue reading.

Bullish Option Strategy: LEAPS call

With C trading below $4, long calls are certainly affordable for long-term bullish investors. For those who agree with Cramer and think C will show strength down the road, the January 2012 4-strike LEAPS calls can be bought for 70 cents per contract.

With a delta of almost 56, these calls can serve as a proxy to the stock at one-fifth the cost. Remember that 10 4-strike calls are essentially equivalent to 1 40-strike call and 100 4 calls are akin to 10 40 calls. When trading larger volumes in low-priced securities, it helps to find competitive stock and option commissions.

The investor risks 100% of the 70-cent premium if C is unable to move back above $4 by January 2012 options expiration. Between the 4 strike and breakeven of $4.70, the investor would get back at least some of the premium paid. Above breakeven, gains are theoretically unlimited at expiration. All charts below are created with the profit/loss calculator tool in a virtual trading account.

Neutral-to-Bearish Option Strategy: Put Ratio Spread

Traders who think C will have a challenging time gaining any upside over the next few months could consider a put ratio spread. This strategy typically consists of selling two out-of-the-money puts and buying one near-the-money put:

-Buy one December 4 put

-Sell two December 3 puts

-Total cost of 30 cents per spread

To the upside, the maximum risk is capped at 30 cents per spread if C is trading above 4. To the downside, risk is capped at $2.30 due to the fact that the stock cannot trade below zero.

Maximum potential profit, if the stock is trading right at the 3 strike at expiration, is limited to $0.70, or the difference in strike prices minus the premium paid. The breakevens for this strategy are $2.30 to the downside (the short strike minus the maximum profit potential) and $3.70 to the upside (the long strike minus the credit paid).

If C is trading higher than $2.30 but lower than $3.70 at expiration, this spread turns a profit. This is a 38% range to the downside.

Citigroup (C) put ratio spread