There can be no doubt the recent interest in shorting Bank of America (NYSE:BAC) and Citigroup (NYSE:C) has come from the upcoming auction of warrants in the companies from the Treasury Department.
When these banks, and others, received Troubled Asset Relief Program (TARP) funds, warrants were issued by the banks to the Treasury to buy shares in the companies at a later date.
Two options were basically available to the banks concerning the warrants. In some cases financial institutions negotiated with the Treasury before they went to auction. Financial firms like Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) were among those choosing to go that route.
Warrants for Bank of America have been agreed to be auctioned on Wednesday, while Citigroup has this time has yet to make a decision whether to negotiate or allow the warrants to go to auction.
So when mentioning investors shorting the companies, with Citigroup they’re basing their decision on believing that’s the route they’re going to choose to go.
Normally how investors make this play is what is called “delta hedging.” In delta hedging they will acquire the warrant and then short the stock. This is based on the assumption the warrant has been outperforming the common stock price, which as mentioned, in most instances has been the case.
Another factor in increased shorting of these two banks is the number of shares increasing, as the banks raised capital by selling more common shares in order to pay back some of their TARP funds, which can dilute the stock and make them less valuable; thus the interest in shorting them.
Even though Bank of America has already paid off the TARP funds they borrowed, it doesn’t change the increased amount of common shares of stock out there, so that still remains a factor in the valuation of the stock over a period of time.
