10/24/08

Pretty Good CD Offer from Citibank

Citibank (C) started advertising a 4% six month CD. That's pretty good considering the national average for six month CDs is around 3.06%. If you've renounced stocks or have savings deposits you don't need for six months, Citi's CD is not a bad place to go (stay within the FDIC limit, though).

The offer seems to indicate that Citi is strapped for cash more than its large rivals, like Chase (JPM) and Bank of America (BAC). This could mean that the stock will head lower. If you're of that opinion, you might consider buying medium or long term puts (I'd do it at the 10 strike).

Here's a plan that might be appealing if you're considering the CD and want to speculate "for free." Calculate how much interest the money you want to buy the CD with will earn over the next six months where you're presently holding it. Then calculate how much it'll earn in the CD. Find the difference between these, and then look at the puts you might want to buy. If the difference between the interest earned on the Citi CD and the earnings where money currently held is equal to or greater than the value of the puts, buy the Citi CD and buy the puts. It's like you're getting the puts for free. If the stock continues to drop, you'll make more money.

That's probably not very clear, so here's a general formula and an example.

This is for money you don't need for the next six months.

Money currently held in account A will earn $x in interest over the next six months.

Money in the Citi six month CD will earn $y in interest over the next six months.

A medium or long term put(s) (at whatever strike you think is best) costs $p.

First, if $y is greater than $x, you should strongly consider buying the CD.

Second, if you want to take a risk and if $y - $x is equal to or greater than $p, you might want to buy the put(s). This way, if Citi stock goes up and the put becomes worthless you'll be no worse off six months from now than if you just kept your money where it is presently. If Citi stock goes down, you'll be better off.

Example: Over the next six months, let's say you'll earn $400 in interest on money you don't need for the next six months. Let's say if you move that money to the Citi CD, you'll earn $750 when the CD matures. That's a $350 difference. It's probably worth it to move your money into the Citi CD.

Now, if you're in the mood to speculate, you can take $350 from your brokerage account and use it to buy puts on Citibank. Should the stock fall, your puts will rise in value and you'll make extra money. Should the puts become worthless, six months from now you'll have earned a net of $400 on the entire enterprise, which is what you would've gotten had you done nothing at all.

Disclosure: At the time of writing I hold no positions in any assets mentioned above.