Morning Update

Yesterday the market closed near the highs of the day with the VIX futures at the lows. When Senator Reid came on TV to say that he did not expect to see a fiscal cliff deal before Christmas the S&P sold off slow and steady, but VIX did not catch a bid. The market then recovered into the close, which suggests traders do not believe Reid and are not worried. Today trader’s attentions will be on the FOMC meeting, which is expected to result in the announcement of additional asset purchases to make up for the end of Operation Twist. Gold is higher this morning and the dollar weaker ahead of the meeting.

AIG has had a busy week in the news, first announcing the sale of most of its International Lease Finance Corporation (ILFC) to the New China Trust Co., and then the government’s announcement that they will sell their remaining stake AIG. This has 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 try to predict its next move. One trader took a large bearish position on the stock by buying 8673 Jan. 34 puts for $0.78 in the final minute of trading on Tuesday. This trade will profit if AIG is below 32.22, 3% lower, at January expiration.

This bearish trade is likely a hedge to a long stock position and is being used to protect the gains seen in yesterday’s trading session. The US 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 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 term AIG looks poised for significant appreciation. First, 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 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 now the shares should appeal to an even wider investor base. Regarding AIG’s losses from Hurricane Sandy, they look big on paper, but when put in context of the company’s $102B equity capital base, do not appear 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, 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 that 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 short 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 selling out of the money puts at levels you are willing to buy the stock. This allows you to get paid to wait for a good entry price and take advantage of any selling pressure the stock sees in the near term.