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American International Group Traders Bet on a Big Move


A long-term strangle is purchased on AIG ahead of this week's earnings report.

Option traders have descended upon American International Group (NYSE:AIG) in droves today, as the storied insurance company prepares to release earnings later this week. As of 2 p.m. EDT today, more than 60,000 AIG options have traded, outpacing typical daily option volume by 38% at this point in the session. Although calls are outpacing puts -- 35,000 to 27,000 -- the most active strike overall is the weekly May 3 41-strike put, where nearly 10,500 contracts have traded, more than 80% of which crossed at the ask price.

Based on the volume-weighted average price (VWAP) of $1.01, the breakeven price on this put at expiration is $39.99 (strike price less VWAP). This is 2.6% below the stock's current price of $41.06, and is just a hair south of the $40 area, which had acted as technical resistance on the stock until last week's breakout. Perhaps today's put buyers believe an earnings setback will knock AIG shares back south of this region.

Meanwhile, another trader is betting on AIG volatility in one direction or the other. Blocks of 1,500 contracts traded simultaneously on the January 2014 45-strike call and the January 2014 40-strike put. Both blocks traded at the ask prices -- of $2.35 and $3.33 per contract, respectively -- and implied volatility has inched higher on both. This is therefore likely to be a long strangle, which employs long puts and long calls to bet on a sharp move in either direction.

In this trade, the strangle buyer will profit if AIG is perched either above $50.68 (call strike plus total debit) or below $34.32 (put strike less net debit) when the options expire next January. This represents a move of 23.4% above or 16.4% below current levels. This strangle has a slight bearish focus, as the put is out of the money by just $1, while the call is out of the money by almost $4.

While this strangle buyer has the advantage of time, he could be hoping that AIG's earnings announcement prompts enough of a move to warrant a very early exit. If past is prologue, however, he may find himself holding onto the call and put for a few more months. In the past eight quarters, AIG has moved an average of negative 2.6% in the entire week following its earnings report. What's more, the largest post-earnings move in the shares (on a weekly basis) was a 12.3% drop in August 2011 (coinciding with a broad-market plunge).

This article by Beth Gaston was originally published on Schaeffer's Investment Research.

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