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News Can Be a Catalyst for a Move

News Can Be a Catalyst for a Move

Sometimes, news can seem to be innocuous. That can be the case in recent news that The Wall Street Journal reported,

“The U.K. Prudential Regulation Authority said Tuesday that it has fined Citigroup Inc. ’s (NYSE: C) U.K. operations £44 million ($56.6 million) for regulatory reporting failures.

The PRA said that between June 19, 2014, and Dec. 31, 2018, Citigroup Global Markets Ltd., the Citibank N.A. London branch and the Citibank Europe PLC U.K. branch failed to submit complete or accurate regulatory returns to the regulator.

“Citi has fully remediated the past regulatory reporting issues identified by the PRA, and settled this matter at the earliest possible opportunity,” a Citi spokesman said.

The PRA, which is part of the Bank of England, said in a press release announcing the fine that there were significant errors in the returns, making them an unreliable source for the regulator to get an accurate picture of Citi’s capital or liquidity position. Citi met its capital and liquidity requirements at all times, the PRA said.

Citi also failed to allocate enough staff to ensure that its reports were accurate, according to the PRA. The bank began working on a significant remediation effort to improve its data quality and internal controls during the PRA’s investigation, the regulator said.

The PRA uses information that banks submit on their capital levels, leverage and liquidity to identify risks in the market and assess compliance.

“Accurate regulatory returns from firms are vital for the PRA in fulfilling our role,” Deputy Governor for Prudential Regulation and Chief Executive of the PRA Sam Woods said.

The regulator said that Citi agreed to resolve the matter and therefore received a 30% discount off the fine.”

Fines, at least since the financial crisis, have become an operating cost for large financial firms and the fines can be in the billions which makes this fine a relatively small matter. But the news comes while the stock is near resistance.

C daily chart

The longer-term chart using weekly data shows that the resistance visible in the daily chart extends back to 2017 and could be formidable.

C weekly chart

For C, the news may not be significant and it is relatively low small news. But the news draws attention to the stock and highlights a potentially bearish pattern, however it is a bearish pattern that could turn bullish and risk management should be a priority.

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in C

For C, we could sell a December 20 $75 call for about $1.65 and buy a December 20 $77 call for about $0.81. This trade generates a credit of $0.84, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $84 The credit received when the trade is opened, $84 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $116. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($0.84).

This trade offers a potential return of about 72% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if C is below $75 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $116 for this trade in C.