Options Action

The Smart Money Is in AIG

President, Stutland Equities
JB Reed | Bloomberg | Getty Images

AIG has had a busy week in the news.

First the insurance company announced the sale of most of its International Lease Finance Corporation (ILFC) to the New China Trust Co. Then the government announced that it will sell its remaining stake in AIG. This sent shares up 3.3% on the week, and 5.7% yesterday.

The headlines also created a flurry of option activity on the stock, as traders attempted to predict its next move. One trader took a large bearish position by buying 8,673 January 34-strike puts for $0.78 each in the final minute of trading on Tuesday. This trade will profit if AIG is below 32.22, or 3% lower, at January expiration.

This bearish trade is probably a hedge on a long stock position, and is likely being used to protect the gains made in yesterday's trading session. The U.S. Treasury's sale will bring 234.1 million shares to market, which could put some pressure on the stock. AIG is also looking at about $1.3 billion in losses from Sandy, and is expected to report a non-operating loss of $4.4 billion in Q2 2013 as a result of selling ILFC. These headwinds could weigh on the stock in the near term, along with profit taking ahead of the "fiscal cliff."

However, over a longer time frame, AIG looks to be poised for significant appreciation.

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The stock has become a favorite of hedge funds, and was one of the most popular stocks among institutions investors last quarter. This shows strong demand for the shares, which makes sense considering that the stock trades at just over half of its book value. Many investors did not want to purchase a partially nationalized company, but with the company completely privatized, the shares should appeal to an even wider investor base.

How about AIG's Hurricane Sandy losses? Well, while they might look big on paper, when you put them in the context of the company's $102 billion equity capital base, you see that they are not likely to have long-term ramifications.

The sale of ILFC for less than book value is another example of short-term pain for a long-term gain. Why? Because ILFC was not profitable, and AIG will now be able to focus on its core insurance business. AIG will also retain at least a 10% stake in ILFC, so it will be able to participate in some of the upside if ILFC is turned around.

While AIG could see some near-term selling pressure, I am a buyer on weakness, and would rather be selling puts than buying them. If you already have an AIG position, protecting profits after a sharp move up is never a bad idea, but I would not be betting against this stock.

To initiate a position in AIG for a long-term trade, I like the idea of selling out-of-the-money puts at levels at which you would be willing to buy the stock. This allows you to get paid to wait for a good entry price, and to take advantage of any selling pressure the stock might see in the near term.

DISCLOSURES: I personally had a bull call spread position that was profitable, but I closed it on Monday, and am now waiting for better levels when the stock pulls back.

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Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."

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