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Call Buyers Think AIG Is Ripe for a Rally

Can the infamous insurer rise 50% in the next 10 months?


AIG, American International GroupAmerican International Group (NYSE:AIG) gained more than 2% on Tuesday, and option players took this opportunity to jump on board with some solidly bullish bets.

The stock moved higher in a down market after Deutsche Bank said the insurer could repurchase $20 billion in stock over the next 12 months. Earlier this month, AIG bought back $3 billion from the U.S. Treasury department, cutting the government’s ownership stake to about 70%.

Over in the options pits, AIG saw 119,000 options trade, 90% of which was on the call side. This compares to average daily options volume of just 31,000. The January 2013 45-strike call was notably active, as more than 16,600 contracts traded versus existing open interest of fewer than 3,000 contracts.

These opening bets appear to have been on the buy side. One way to tell this is by the 13-cent advance in the call option, which closed the day at a bid price of 35 cents and an ask price of 39 cents. Given its delta of 11% and the 61-cent advance in the stock, the option should have gained only about 6.5 cents. Buying demand, however, sent the prices higher. Going forward, a delta of 11 indicates that the option will gain 11 cents for every $1 move higher in the stock (assuming all other factors are equal).

Caitlin Duffy with Forbes noted that one block of 7,280 calls was apparently purchased for a premium of 35 cents per contract (more than $250,000 for the entire block).

This entire premium is at risk if the call buyer holds the option through expiration and AIG fails to overcome the $45 level. Gains, however, are theoretically unlimited if the stock rallies beyond the strike price (by an amount greater than the credit paid to enter the position). Breakeven for this particular block trade (at expiration) is $45.35, or the strike price plus the premium paid. This is 54% above yesterday’s closing price of $29.67.

AIG has not traded in the $45 region since last January. In fact, since last May, the stock has been pretty content to stay in a rough range between $20 and $30. With yesterday’s 2% move higher, the stock is nearing the top of this range. AIG is up 30% year-to-date but still down 18% over the past 12 months.

Long-term option buyers are hoping the short-term upward momentum continues indefinitely, or at least through the new year.

As of this writing, Beth Gaston Moon does not own any shares mentioned here.

Article printed from InvestorPlace Media,

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