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« BC BS | Main | Terminators »

May 22, 2009


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Black-Scholes is not perfect, and is one of the equations that mispriced many options leading to today's mess, and was so useful at LTCM.

ONB received $100M 6 months ago. Treasury got back $100M (preferred paid back at par), pref dividend $2.5M (5%/yr), and the $1.2M for the warrants. An annualized 7.4% return on their investment. If we get that rate of return, assuming TARP funds get completely repaid in 2 years, the feds would make $115Bln profit on the program. The warrants were a bonus, part of the cost of getting TARP funds.

"each of the 813,000 warrants had a strike price of $18.45...Based on that volatility and that rate, the Black-Scholes options valuation tool appraised one Old National warrant at $7.18. The bank paid the U.S. $1.48 for each." ONB is currently trading at $12.22. To justify the $7/share option price, ONB stock would have to more than double. Are bank stocks going to double on a whole? If that happens, what will the rest of the market do?

The worse situation is the preferred to common stock swap, as the ratio of # of shares of common to each preferred has not been negotiated the best. It is this where the $25B put into Citi, only buys us a 40% stake, while Citi's market cap is only $20B today. If we put $25B into Citi common stock today, we would buy it out, with $5B to spare!

Valuing other options: Citi got its TARP funds on 10/28, when its common was at $13, now it is at $4. BAC was at $22, now at $11. For the Citi warrants to be worth anything, Citi stock would have to over triple, and Bank of America would have to double.

Right now, Citi options at $12 are trading at 9 cents/share. ONB options at 17.50 appear to be trading between $0.75-$1.35/share.
If these analysts really thought those options were so valuable, wouldn't they be scooping them up at such reduced prices, pushing the price up?

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