Two Options Strategies in American International Group (AIG): One for Bulls and One For Bears
Jim Cramer took a bearish stance in American International Group (NYSE: AIG), last Thursday on CNBC’s Mad Money, calling the stock a “sell – sell –sell!” Cramer said he thinks the company owes too much money to the government and should have never enacted a reverse split. Over the weekend, however, Barron’s spoke with fund manager Bruce Berkowitz, who said he likes AIG and other big financials, as they are potentially undervalued. AIG closed at $34.21 on Friday and rose modestly in Monday’s trading.
AIG is certainly a controversial play, and now we’ve recently heard vocal pundits in both the bullish and bearish camp. As I’ve mentioned before, AIG, with all of its very public challenges, is extremely hard to borrow. Because so many investors are trying to short AIG these days, the cost of borrowing the shares is more than 20% per year. For this reason, bears might consider options as one alternative to taking a short position in the stock. Options can also be a reasonable choice for bullish investors, as they can put less capital at risk (among other potential advantages).
Below are just two examples of ways stock traders might consider using options to trade AIG in lieu of buying (or attempting to sell) the stock outright. These are not buy-sell-hold recommendations, just a look at two potential bullish and bearish strategies.
*Option prices given as of Monday afternoon
Bullish Option Strategy: Bull Put Spread
Investors who, like Berkowitz, believe AIG could be undervalued at current levels, could consider selling put spreads. One relatively conservative way to play this potentially volatile stock is through bull put spreads. The August 34/20 put spread can be sold to open for about $5.00 per spread (by selling the 34 put and buying the 20 put). The trader will keep the maximum potential profit ($5.00, or the credit collected) if AIG is trading at or above $34 when these options expire on Aug 20. The maximum potential loss, which occurs if AIG is trading at or below $20 at expiration, is $9.00 per spread. Finally, breakeven for this strategy is $29, or the short strike minus the credit collected. Anywhere above this level, the trader will earn at least some of the maximum potential profit.
Bearish Option Strategy: Bear Call Spread
For those who agree with Cramer that AIG is a sell, you may have found that put protection is a bit expensive (given the hard-to-borrow angle). But, one way to play the stock bearishly is to sell longer-term bear call spreads. The November 35/45 call spread can currently be sold for about $2.50 (by selling the 35 call and buying the 45 call). The trader can keep 100% of the credit collected as profit (if AIG is trading below $35 when these options expire. Maximum loss is capped at $7.50 at expiration, and would happen if AIG zooms higher and is trading above $45 at November expiration. Breakeven is $37.50; anywhere below this point, the trade will be profitable. Between $37.50 and $45, losses accrue until hitting a ceiling at the 45 strike.
Your Take?
Are you in the Cramer camp or do you prefer the optimistic outlook of Bruce Berkowitz? We’d love to hear your rationale in the comments section.
If you are new to options and still trying to get your feet wet, it’s helpful to start by trying your trades in a virtual trading account.
Photo Credit: kalwa
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