Unusual Swings in Stock Prices at Pacific Capital

Pacific Capital’s share price soared on Friday, creating a pattern that should provoke some questions.

Pacific Capital, a small bank headquartered in Santa Barbara, California, jumped 48 percent on Friday, from 87 cents per share to $1.29. It was the largest jump since November 23, when share prices finished at $1.25.  That wrapped up a dramatic week, when share prices increase 86.5 percent over four days.  That has turned out to be fleeting gain.  This morning, Pacific Capital’s shares dropped 28 percent in the first 19 minutes of trading.

Both weeks have one thing in common – the expiration date for equity.  This is a link to the calendar of options expirations in 2009.  This link provides a good explanation of how options work.  Equity options end after the third week of the month.  Traders close out positions over the weekend, meaning that option positions are either in or out of the money at Friday’s close.

Here is one scenario of how a trader might make money on options for his or her financial institution.  An options trader could sell puts or buy calls.  Buyers of puts would expect that share price to drop.  These instruments hold two kinds of value – intrinsic and time.  The intrinsic value is the difference in the contract price (i.e. $2.50) and the current market price.  The time value is based on an estimate of the expected value of the remaining time.

A holder of a $2.50 put in PCBC was sitting pretty last week -  each put would have been worth about $1.75 on Thursday when the shares were at 86 cents with one day to go.  That value evaporated on Friday, though, as puts ultimately exchanged at $1.08.  The same kind of change could happen on the call side.

Traders could make money two ways in that scenario.  For one, he or she would make a transactional profit on selling puts or calls.  Demand for puts and calls increases with volatility.  Second, there would be money to be made on the change in value of options.  Those $2.50 puts, for instance, sold at $1.50 or more for much of the month.

It takes some wealth for one institution to change the price of a stock.  That said, it is much easier with a small company.  If the hypothetical trader was working for an institution with substantial wealth, it would be possible.  That options trader could work with the equity traders.  The buyer would have to keep on buying, but the “buy” would be relatively little.  The 7.6 million shares transacted in PCBC on Friday probably cost less than $10 million overall.  The ability to change the price in equity is not something that most investor have, but it is well within the reach of corporate or institutional investors.

The buying institution would take some risk, of course, that they would be buying shares at an elevated price.  The only escape, of course, would be to dump the newly acquired shares while the price was still high.  That is exactly what is happening this morning. The shares have given away almost half their gains, on a volume that has exceeded PCBC’s daily average volume before noon.

I cannot track this next bit of information, but traders were reporting that a single block trade of 2.1 million shares went in just before close of trading on Friday.  As well, three trades accounted for 35 percent of all volume in PCBC.

Why this Matters

There are several reasons why these fluctuations matter, and those reasons reach into the interests of several different parties.  First and foremost, Pacific Capital is a victim in this scenario.  Their share price matters as they struggle to raise regulatory capital.

Pacific Capital’s deposits are also at risk.  The fluctuation in equity price influences regulatory capital. Pacific Capital is already undercapitalized. With manipulation, that basis is vulnerable.  If the equity is threatened, it enhances the prospect that the bank will be taken over.  While the holders of guaranteed deposits would be made whole by the FDIC, it is taxpayers that are ultimately on the hook for that outcome.  The fancy of traders is our loss.

These are dramatic swings for a small company such as  Pacific Capital.  It has about $52 million in market capitalization.  In this arena, a large trader (s) could easily use market size to influence short-term prices.  That is what could be happening.  On Friday, about 7.6 million PCBC shares were traded.  That is a very high volume.  On the previous two trading days, for instance, about 300,000 and 460,000 shares exchanged.   7.6 million amounts to about 1 in 7 of outstanding shares.  PCBC never reached a volume of more than 1 million shares from Feb. 23 to June 16th, and before Feb. 20th, you would have to go back to September before there was another day with 7 figure volume.  Indeed, the next highest trading day of the year, with about 4.73 million shares, was November 20th.  That happens to have been the options expiration day for November.

The next table puts these volumes in the context of their neighboring trading days.

PCBC shares Fluctuating on Options Expiration Days

You can see the difference.  This month was an aberration, and the previous month (November) was higher than normal. September was high as well.

September was an unusual time for PCBC, though.  Its quarterly financial report was filed at the end of the month.  It was under the scope of the FDIC, as well.  The FDIC had issued a warning to the bank that it needed to shore up its Tier One leverage ratio.  The bank’s TOL ratio had been less than 6 percent.  The FDIC insisted that PCBC elevate its regulatory capital to above 9 percent by September 30th.  Either of these factors could provoke more trading.

The Need for a Regulatory Response

This might be an example of the market responding to a lack of safety and soundness.  In the end, PCBC did not elevate its Tier One Capital ratio.  The FDIC did not act on its warning, however. There is a vacuum here.  The FDIC has allowed Pacific Capital to stumble along on life support – a zombie bank that is still banking.

Options exist for uncertainty.  A trader can use an option to limit risk.  Calls are traded on positive movement, and puts are traded for negative change in share prices.  The greater the uncertainty in a stock’s price going forward, the greater interest in using options to mitigate that risk.

With zombie status and regulatory attention, Pacific Capital has developed greater volatility.  This volume suggests that there is money to be made in the short run with options trading.  Over the last 5 years, Pacific Capital has been very stable.  Indeed, its beta over that time is 0.17!  A beta of less than 1 reflects volatility that is lower than the average for the market.  A beta of more than one, by contrast, shows volatility that is greater than the market as a whole.  Over the last 75 days, though, its is changing at a volatility that is many times the market.  This link shows the change in share price on a daily basis at Pacific Capital, relative to the change in the price of the S&P 500 (IVV) and the Russell 2000 (IWW).

All of this is more of a reason, lacking action by the FDIC, to compel the SEC to move its focus to Pacific Capital.  The smart guys in the room are at work here, using the power of their size or perhaps of their trading algorithms, to move markets in ways that undermine the equity of a vulnerable bank.  It remains an issue of safety and soundness, which is the concern of the FDIC, but it is also something that should matter to small investors that cannot manipulate markets.