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AIG Rises from Ashes, Feel the Burn

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Insurance company looks to be on the road to revival.

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Editor's Note: This article was originally published on the Buzz & Banter. It's being reposted here for the benefit of the Minyanville community.

I'm not a huge fan of rap music but if any company were to inherit the large shoes left by the passing of Big Punisher, it would be AIG (AIG). No one in the rap game has inflicted as much pain and punishment, and set such an ugly precedent, as this rogue financial firm unleashed on both Wall Street and Main Street.

We all know about the derivatives-based demised that has cost taxpayers -- those suburban kids that just wanted to be cool and co-opted the desire for blinging returns by buying into hedge funds -- some $180 billion, though I hear that repayments are shortly at hand. More to the moment is that pros, or those with street cred that should know better, are now being burned as AIG rises like some Phoenix house resident from the ashes of its addiction to leverage dubious derivative transactions.

Putting the reverse split aside -- and while that's a zero-sum game, it might have drawn in more of the big money traders that don't like, or are restricted from trading in single-digit stocks -- the soaring of AIG shares is nothing short of spectacular. Today's 25% gain to $48 puts the stock up some 550% in the past two months.

Winners?

One would think that such a huge run would be applauded, but as mentioned above, there are no real investors, AIG. Yes, there's broad ownership via the government's stake, but how and when any monetary recovery will be distributed is dubious and doubtful.

Right now the biggest winner seems to be Hank Greenberg. Suddenly lionized, the disgraced patriarch is the being mentioned as the best man to be able to regain control of the financial Frankenstein he created.

I say good luck to him. I'd hate to see some of his philanthropy, which includes the naming of Sloan-Kettering Cancer Center, take on the tone of an Enron or even CitiGroup (C) ballpark.

Profiting From Others' Pain

Legacy aside, the here and now has many traders scrambling for their financial life. The stock has become nearly impossible to borrow, which means that people need to turn to the options market to protect or initiate short positions. Even if you can borrow shares of AIG, it's costing nearly 30% annualized rate to short the shares. Option traders are now bidding up puts and calls to try to capture expectations of more volatility. Volume in the September options, in which several strikes above the $45 level have just been added today, is running seven times the daily average.

This cost of carry gets translated into higher premiums for the options. The implied volatility of AIG options has jumped to 125% from 95% just one week ago. This is also now a small premium to the 30-day historical volatility. For the past five months the IV had been at a discount to the stock's HV, so option prices are now relatively expensive.

One way to take advantage of this spike in price and implied volatility would be to establish positions for a net credit. But given that this stock is in such a state of flux, it makes sense to be hedged. One way to go might be to sell iron condors or even calendar spreads, both of which limit the potential loss but benefit from a decline in implied volatility.

The implosion of AIG has the world up in arms. Join Hoofy & Boo as they take you through what happened, from start to finish.

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Position in AIG

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