It seems that the trading momentum for AIG (AIG) is again faltering, yet making near- or long-term option trades is far from simple under the circumstances.
This morning, AIG traded lower by almost 8%, down below $41 after shares were downgraded to “underperform” by Keefe, Bruyette & Woods, which is really a “sell like hell” rating. The new price target is $6, and the report shows fear that there is little long-term value in the common stock despite the strength of some of the underlying business entities and franchises inside AIG.
This follows on the heels of last week’s concerns about the caveats in the government looking to sell its AIG stake.
With all of this going on, it seems like a good idea to take a look at just how much it would cost to bet on AIG with options.
There are two outlier bets here: AIG’s total failure and AIG’s total success.
Betting on AIG’s Demise
Just taking a short-sale and hoping for the best or even short selling with a hedge via buying a call might not be the same as taking a deleveraged bet here via buying long-term put options.
The long-term bets being made here in the January 2012 puts are actually out into the AIG Jan 2012 15 Puts (AIG 120121P00015000) at $2.60. We have seen more than 2,000 of those contracts trade versus a prior open interest of more than 20,000 contracts. The problem here is that this requires more than a 60% price drop for the options to come in the money.
The AIG Jan 2012 22.50 Puts (AIG 120121P00022500) are at $4.70, and these require “only” about a 45% drop from the stock’s current price for these options to be in the money.
So betting on AIG’s failure is not a cheap notion when you begin to take a long-term position in puts. Plus, it is obvious that the government still cannot kill this entity despite a notion of going after the weaker of the “too big to fail” financial firms.
Betting on AIG’s Success
Then there is the other side of the coin. What if all the bears are wrong, and AIG gets its act together under CEO Robert Benmosche and pays back all of its obligations through time?
That seems to be the real outlier bet, but playing the long side is even more expensive.
Buying the AIG Jan 2012 65 Calls (AIG 120121C00065000), which implies a 62% upside, costs $6.77 on last look. And the AIG Jan 2012 80 Calls (AIG 120121C00080000), implying a double in the shares, still cost $5.
Playing the long and short LEAPs here is not cheap. That also makes hedging a long or short position a very expensive proposition.
Even making an outlier bet in the near-term solely based on volatility is expensive. The June 40 straddle costs $8, meaning AIG has to fall under $32 or rise above $48 before June 18.
The bottom line: Making any AIG outlier bets today requires extreme conviction if you’re going to put up that kind of dough.
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