Wednesday’s trading session brought profits and happiness to financial stock owners everywhere. By day’s end, the Financial Sector Fund (NYSEARCA:XLF) climbed 1.6% taking out key resistance in the process.
Chief among the beneficiaries of XLF’s strength is American International Group Inc (NYSE:AIG). As we’ll highlight below, AIG stock is on the verge of a notable breakout.
Since soaring higher on better-than-expected earnings in early August, AIG shares have been in base-building mode. Gains have been digested while overbought conditions have dissipated. And with the oft-watched 50-day moving average now caught up, a breakout appears imminent.
The beautiful thing about stocks emerging from a multimonth base is twofold. First, it provides an ultra-clean entry point. If AIG can take out the $60 resistance zone, then it’s game-on for bullish trades.
It attempted such a breach Wednesday but failed to close above the ceiling. Watch for another attempt in the days ahead to see if buyers have the mustard to succeed.
A second benefit is the bevy of bullish omens that accompany the breakout. When a stock finally takes out a ceiling that has previously halted any and all rally attempts, it’s a not-so-subtle shift in character. Consider it a sign on the Street to buyers everywhere that this particular stock has finally found sufficient supporters to kick off its next advance.
The AIG Call Trade
If you think AIG is destined for further upside, consider entering a long call diagonal spread. Buy the Dec $57.50 call option while selling the Oct $61.50 call for a net debit of $3.41.
The rationale for the trade structure is simple. We’re buying a three-month in-the-money call to get bullish on AIG. Then, we’re selling a two-week out-of-the-money call against it to reduce the overall cost, and therefore risk, of the position.
The best-case scenario is to have AIG sitting near $61.50 at October expiration. The expected gain is around $75, or roughly 20%. The max risk is $3.41, but you can pare back the loss by exiting if AIG takes out support at $57.50.
At the time of this writing Tyler Craig had no positions in any of the aforementioned securities.
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