CIBC versus BMO

Time to switch? Use options?

Quite some time ago I wrote about a strategy of buying “in the money” CIBC options as a way to benefit from what I saw as the then depressed price of CIBC shares. By October 31, 2023 I had accumulated calls on 12,000 Canadian Imperial Bank of Commerce shares at a strike price of CDN$50 per share at a total cost including commissions of CDN$77,279.92 and was in the ditch over CDN$26,000 on the holding.

Fast forward to today, and the Commerce shares now trade at CDN$81.46 and the options now have an “in the money” value of CDN$377,520. As you might have guessed, I closed the position happy to have turned a profit.

I chose the Commerce back then because its trading price was very close to book value, and it is trite valuation theory that banks without accouting problems or extreme and poorly reserved credit risk are worth more or less “book value” since there is effectively cash on both sides of the balance sheet.

CIBC shares today trade at a premium to their book value which approximates CDN$57 a share.

Bank of Montreal (BMO.TO) is a horse of a different colour. Investors have shunned the name since it reported higher than expected provisions for credit losses (PCL’s) last quarter and, despite good control over operating expenses, disappointed the market. At a trading price of just over CDN$112 per share, BMO shares now trade at close to book value of CDN$105 per share and options to buy those shares with an expiry date of January 15, 2027 at a strike price of CDN$90 per share trade at CDN$22.50 while the stock trades at CDN$112.74, meaning the option is trading at a discount to its intrinsic value despite having about two and one half years until the option expires.

I like that so I opened a position in those options. Unlike many American banks that make detailed disclosure only quarterly (the U.S. has periodic rather than continuous disclosure securities laws) Canadian banks have to disclose any material fact that can affect the price or value of their shares at the time that fact arises, and our banks are supervised by the Office of the Superintendent of Financial Institutions. I think investors err on the side of believing BMO has mounting credit problems while in my opinion it is more likely that BMO is taking a conservative approach to its PCL provisions and within a few quarters will shrug off the concerns and begin to trade at a price more or less in line with the price to book rations of its peers.

CIBC is a good per for BMO and at today’s price trades at a premium to book value of over 40% and a similar valuation for BMO puts the stock at CDN$160 and the options at CDN$70.00. That assumes BMO book value neither rises nor falls in the two and one half years until the option expires, but in my view BMO will always pay dividends at less than net income and book value will rise a bit in the tenure of the option.

Who knows? But for me this is a businessman’s gamble that promises somewhere between a total loss of investment or a triple within 30 months. If it works out as well as my CIBC option bet, I will be reasonably satisfied.