Description

This is another simple idea from me and is in regards to the arbitrage between the pref A price at CIT and the ability to short options. CIT has announced a proposed restructuring of the company that will result in the common stock receiving approximately 2.5% of the outstanding shares in the company and the pref A stock receiving 0.4% in the company. With 392 million common shares out and 14 million pref A shares, we can see that the parity ratio between the common and the preferred is 1:4.48 (i.e. you will get the same amount of value for each 1 share of prefs that you own as you would if you owned 4.48 shares of common). If the company is not successful in its restructuring plan and goes into bankruptcy, both the common and the prefs will be wiped out, but I expect the prefs to trade a bit better than the common.

My proposed trade is to short 4 calls for $0.60 each for each 1 share of CIT Pref A that you purchase. In this case, you would take in $2.40 in call premium at the outset and spend $1.90 for the CIT stock for a net inflow of $0.50. We can now say that there are essentially three outcomes in that the offer could be successful and CIT common could trade north of $1, the offer could be successful and the common could trade under $1, or the offer could fail and the company would enter bankruptcy. Let's examine all 3:

1) CIT's offer is successful and the common trades above $1. In this case, you are long 4.48 shares of CIT's new common and short 4 shares through your short call position for a net long position of 0.48 shares worth something more than $0.48 (because the stock is trading above $1). In this case, you've made your initial $0.50 from selling the calls net of the prefs and you've got at least $0.48 in value from your long stock.

2) CIT's offer is successful and the common trades below $1. In this case, you are long 4.48 shares of CIT's new common stock (worth something - I estimate fair value at $0.50 per share) and your short calls expire worthless. You've made 4.48 * new common price + $0.50 from your initial net premium inflow.

3) CIT's offer fails and the common trades way down on bankruptcy. Your short calls should expire worthless and you should still be able to sell your Pref A's for something - maybe $0.25 each. In this case, you've made $0.75 - the $0.50 initial call premium and the $0.25 that you can liquidate the Pref As for.

Note that CIT is also planning to do a reverse split of its stock post the restructuring. This is typically very good for poeple who are short calls at $1 due to the lower bounding at $0 and the normal distribution for call pricing.

Catalyst

Restructuring plan or bankruptcy