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Kevin Kersten's Analyst Insights

Options Analyst Writer
Kevin Kersten
Author Bio

April 29, 2013 - Is it Time to Adopt an Unloved Stock?

American International Group better known as AIG became a bit infamous during the sub-prime financial crisis. The insurance company bet heavily on real estate derivatives and received a $182 billion government bailout. The company today is only valued at 3% of its pre-crash levels, but it is also up more than 400% from the bottom.

Arguments could be made that AIG should have been allowed to fail. It would have been a messy bankruptcy and costly to many involved. When the government bailed out AIG, it got a huge amount of stock, giving it control over the company. With the government mandate, executives cleaned up the mess as best as they could. Many divisions were sold off, positions were closed and books were sanitized. Once the mess was cleaned up, the government sold its stock and left the business. While there are still some warrants outstanding which might allow the government to make more money if the stock appreciates, stock positions have all been sold. The government has gotten its money back, including a little extra, but more importantly it cleaned up the mess quicker and more effectively than bankruptcy would have.

Some investors may never touch AIG again. If you owned stock in the company before; you saw your equity almost completely wiped out. Of course, if AIG had gone through bankruptcy, all the stockholders equity would have been wiped out. Given that there are a lot of companies in the market, a few are going to come to an abrupt end. I suppose a crisis of this nature could be sort of like getting bitten by a dog. While many people have gotten bitten, most overcome the fear and are once again able to  pet dogs receive love. There are of course many companies in the market; so people can invest in other companies. If enough investors were to stay away; it could even drive up the returns for those who do invest.

Earnings are expected from AIG  on May 2. Analyst expect earnings of $0.87 per sahre. That may be less than last year where the company reported $1.65 in first quarter earnings.  In the previous quarter, the company reported it reported earnings of $0.20 compared to estimates for a $0.08 loss and below the prior year's $0.82. Looking at long-term earnings, there has been a decreasing trend over the last few years. After a loss of $756.90 in 2008, and a loss of $86 per share in 2009 the company has pulled in profits in 2010 ($14.24), 2011 ($8.60) and 2012 ($4.44). Over the last three years the trend has been decreasing, which is not normally what we would like to see. On a positive note, all four quarters last year were profitable and it seems as if earnings are steadying themselves after a very turbulent period.

The stock action is also of interest. Before the crisis the stock peaked near $2,500 (adjusted for splits) a share; but over the last two years has mostly been trending up in the $20-40 range. The stock chart is a little jumpy and near a two-year high. This volatility could feed option prices and indicate the stock is approaching an area of resistance. S&P rates this stock with a 4 STARS buy rating.

Things are turning around at AIG, the company is still selling off some interests; and it is streamlining operations and seeking to focus on property, casualty, life and retirement savings industries. As things turn around, this stock could see some appreciation. The company is a little unloved right now -a bit like a dog in the pound- and this could make it a better than average pick for an investor. It is understandable that some investors are staying away; but it may also be the time to buy. Picking a stock at the bottom of a range is almost impossible. Although the stock price has been rising, it appears it will be a little while before earnings completely rebound. While an investor could just buy the stock and hold it, they could also sell a call to lower their cost basis for buying the stock. There is a chance that the  stock might take off in a few months and the option trade caps profits. It could also lower costs in a sideways trend. In a few months, when one call expires, the investor could look at it again to see if they want to sell another one call or just hold the stock long waiting for an upward trend.

AIG is trading at $41.60 and the August 42 call is going for $2.21 a share. If an investor buys the stock at $41.60 then sells the 42 call for $2.31 (at the same time) he can enter a transaction for a $39.39 net debit. This trade will have a 6.9% assigned return and 5.6% of downside protection. Annualized a 6.9% return over 115 days is about a 22% return (for comparison purposes only). If the stock expires below $42, the option will not be assigned. At that point the investor can sell another option or sell the stock. If the stock expires above $42, the stock will be called away, but the investor will receive the full 6.9% assigned return.  Sometimes right before the stock is called away, investors will buy back the option and sell one in a future month, rolling the position out.

Other complex trades are possible on the stock as well. For example, if an investor thinks there will be a drop in the stock, he could use some of the premium from the call sale to purchase a protective put at a lower level. The August 37 put costs $0.92, or he could even purchase an out of the money call several strikes higher, if he thought the stock was going to shoot up. This might not be done right away, as one could wait and do it later if they wanted to. We'll leave consideration of those strategies to individual investors.

As an unloved stock, AIG has a lot of potential for rebound. Adopting a little of this stock into your portfolio might provide some nice cash through a covered call. Selling calls while waiting for things to turn around might be one way to play this stock.

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