The darling of the day traders is ready to make its final curtain call. After the final bell on May 6, the most widely traded stock will finalize a reverse stock split that will see a tenfold increase in its share price, making it less attractive to short-term traders.
Citi is the stock nearing the 10:1 reverse split, which will turn a $4.50 stock into a $45 stock overnight, thus raising the risk parameters for an issue that has helped legions of traders on Wall Street make a quick buck — from upstairs prop traders to brokers on the floor of the New York Stock Exchange.
The ramifications are widespread and not good news for certain players, such as high frequency traders and other types of day traders in an industry in which trading flows have shrunk to their lowest since 2007. Citi accounts for roughly one-tenth of total U.S. trading volume.
"With the reverse split, I think the parity trade will go away in Citi," said Keith Bliss, senior vice president and director of sales and marketing at Cuttone & Co. "Volumes in Citi will shrink and the stock will go from a $4.50 stock to a $45 stock. The inherent risk of trading 500 shares of Cit at $45 is a lot different than at $4.50."
The smaller float will lift the share price roughly tenfold. Over the last year, Citi has traded in a range of $3.53 to $5.15.
Given the cheapness of Citi stock and large outstanding amount of tradable shares after the bank’s near collapse, Citi shares became a profitable trade of many traders looking to trade a large liquid stock and make money from it. This is often referred to as "the parity trade."
The parity trade works like this: When a trade in Citi occurs, executed stock is allocated equally to three groups participating at that time – the Designated Market Maker (DMM), NYSE Floor brokers, and Super DOT, the system in which other public orders enter the market electronically. The equal allocation occurs because those groups are on parity with one another.
For example, when 15,000 shares of Citi trades on the NYSE Classic market, the DMM gets 5000 shares, the floor broker gets 5000 shares. The last 5000 shares go to Super DOT and orders there are filled on a time-priority basis.
One trading veteran explained that fast traders exploit the parity trade by sending their orders directly and electronically to the NYSE Euronext specialists on the trading floor who then "taps" in the order into his electronic tablet. The order then gets executed within the exchange, at the top of the trading book. This bypasses orders resting in Super DOT order book. The floor broker earns a fixed commission on the trade and the upstairs desk gets the liquidity rebate from the exchange.
"The order gets done right away – it doesn’t sit in the queue," the veteran said. "If an order comes to us and we send it then we have to wait in line. You could be way back in the order book and never get done on anything. "
However, sending orders directly to the floor brokers electronically could cost more due to higher commissions charged for this service. According to NYSE Classic pricing, those who send orders electronically through Super DOT are paid a 15 mil rebate to provide liquidity and charged 21 mils to take liquidity. If an order goes through a floor broker, he gets paid 17 mils to provide liquidity and is charged 23 mils to take liquidity.
So as Citi’s share price catapults higher as a result of the reverse split, executing the Citi parity trade become less profitable, traders said. And with Citi trading less often, prop traders, the exchanges and the floor brokers will all see their slice of the parity trade profit disappear.
According to Peter Weiler, head of sales at agency broker and vendor Abel/Noser, fast money traders and small brokers trade Citi shares all day, making money on small changes in the stock’s price.
"Citi is Ground Zero for high frequency traders," Weiler said. "They do a lot of trading in Citi." Any changes in the Citi parity trade, he added, will have widespread earnings ramifications for all involved.
Citi stock is traded more frequently than any other on a per day basis, according to Rosenblatt Securities, in a 2010 study. According to its data, 902 million shares of Citi trade per day which is about 11 percent of total U.S. equity volume. Based on that number, a reverse split could mean a loss of 1.8 billion in share volume per month for Nasdaq OMX and 3.4 billion for NYSE Euronext. This translates roughly into a quarterly revenue loss of about $3.7 million for the NYSE and $1.4 million for Nasdaq. And that’s no small potatoes.
Citigroup, the nation’s third largest U.S. bank, reported its first-quarter profit fell 32 percent, slightly beating expectations. It also reported first quarter net revenue fell 22 percent, more than expected, to $19.7 billion, due to a slump in its securities and trading unit and tepid consumer banking results, especially in North America.
Citigroup said it earned $3.0 billion, or 10 cents per share, down from $4.4 billion, or 15 cents per share, a year earlier. Analysts on average had expected it to earn 9 cents per share.
Cuttone’s Bliss said that the parity trade really only works in very liquid, low priced stocks like Citi and select others. And firms that have invested time and money in the infrastructure to execute these types of trades won’t let these costly systems sit idle.He declined to speculate on what other potential stocks could be candidates for the parity trade, but did say there are stocks out there that make suitable candidates.
"Time will tell what the effect is of the Citi parity trade going away," he said. "My guess is that companies who have built trading regimes around this type of trade will likely be moving into another parity trade or opportunities. It’s unlikely these guys will stop using this trading style."
