From Barron's The Striking Price column:
Oppenheimer says to reap the rewards of margin with a long-term call on the bank's low-priced stock.
CHEAP STOCKS AND LEVERAGE are a great combination for making money, or a recipe for a financial bomb.
Aggressive investors comfortable with either outcome should consider buying long-term call options on Citigroup (C) that supercharges potential returns on a stock that is too cheap to buy on margin.
Citigroup's share price falls below the New York Stock Exchange's rule that says stocks that cost less than $5 cannot be bought on margin.
To create the leverage that comes with buying stocks for a fraction of their market price—which is the benefit of margin—aggressive investors can buy Citigroup's January $4 calls that expire in 2013 and recently cost $1.20 with the stock at $4.30.
Since one options contract equals 100 shares of stock, an investor could spend $600 to control 500 shares of Citigroup stock, compared to spending $2150 to buy the actual stock.
Sub-$5 stocks like Citigroup are considered by many sophisticated investors to be "perpetual options" because the cost is nearly as low as buying options. The perpetual adjective reflects the fact, unlike options contracts, stocks never expire. But stocks lack the leverage inherent in options contracts, which is what makes the Citigroup call trade attractive.
"This is a double option, and it has the added benefit of letting time work for you, not against you," says Michael Schwartz, Oppenheimer & Co.'s chief options strategist.
He advised clients to consider the Citigroup January $4 call that expires in 2013 trade to establish a position in a stock that his colleague, bank analyst Chris Kotowski, believes could be poised to behave like a growth stock rather than a battered value stock.
With Citigroup trading at about $4.30, Kotowski thinks the stock will trade to $5.20 within 18 months. He rates the stock Outperform, and indeed the shares have done just that, gaining some 25% this year, far outperforming the Standard & Poor's 500 Index....MORE