Is AIG Still A Buy?

On February 11^th, I suggested that American International Group (NYSE: AIG) was a low risk/high probability buy near $25. My thesis was based on market reaction to its asset sales and encouraging price action in the shares as they found support above $20 and threatened to break through the 20- and 50-day moving averages.

Here’s an update of the chart:

The obvious story this picture tells is that AIG is above the 200-day moving average and that the 20- and 50-day have crossed positive. Both of these facts provide more encouragement for technical traders, and for portfolio managers who already like the stock fundamentally. And it doesn’t hurt that on the weekly chart, although the 20- and 50-week moving averages have crossed negative, the stock is above these active trend markers, which surround the $30 level.

A Big Sprawling Bull Call Spread for only $2.40

This morning we spotted an interesting bullish options play in AIG, where an investor bought 5,000 January 50/75 call spreads for about $2.40 each. The net cash outlay for this strategy is 5,000 x $2.40 x 100 shares per option contract = $1.2 million. The investor stands to gain potential profits of $22.60 per spread, or a total of $11.3 million, if AIG shares hit $75 or higher by January 2011 options expiration.

Talk about bullish. This option player is hoping for the stock to double in the next three quarters, but will begin to make profits even before then if the stock continues to climb toward $50. Not only did they give themselves time for this strategy to work, but they paid less for the farther-out options in terms of implied volatility, which tends to hover around 85-90% for near-term expirations but is only at 75% for the January series. For more details on this trade, see Karla Yeh’s report here.

What About the Business Fundamentals?

All this chart and options talk is fine, but if you’re going to risk money on this hobbled insurance giant who still owes big dough to U.S. taxpayers, you had better have some idea of what the company is actually going to do to make money for investors besides watch its stock price run up. When I want to know what potential a financial company has to earn profits and manage its risk, I listen to a few experts and one of my favorites is Christopher Whalen of Institutional Risk Analytics.

In an interview on March 1^st with Southern California Public Radio station KPCC, Whalen talked about the line that AIG walks when it succumbs to public pressure to repay the U.S. government by selling valuable assets:

“It’s a good thing, but these are some of the best assets that AIG has so I’m not sure we’re going to see anything like the proceeds that we need for the government to be paid back in full,” he said.

“Once you sell the Asian business, which, as I say, is one of the most attractive businesses they have, and you lose that cash flow you lose, that revenue what’s left is going to be worthless, by definition,” Whalen said.

And since AIG still hasn’t returned to profitability and may not for some time, what is it investors are buying? The company lost $9 billion in the fourth quarter of 2009 even as the financial system recovers and the housing market stabilizes. Without profitable business units that could generate revenue in the future, are investors merely banking on the nearly blank check of government life support to continue giving the company a long-term guarantee at future success?

Those are important questions and next week I will dig deeper to find out what some bullish financial analysts think about AIG to plot a course for how much higher the stock can go from here. Until then, the bulls appear in charge and all dips to $30 can be used as opportunities to accumulate shares or call options.

“Mind the Risk, Bank the Profits!”