Posted on 23 Sep 2009
American International Group Inc. (AIG) has recently morphed into a playground for speculators.
At a traders meeting before the market opened on Monday, Scott Redler, chief strategist at hedge fund T3 Capital Management, noted that AIG's stock hadn't moved much for days and was ripe for a breakout. Whether it headed up or down, he said, the traders should be ready.
AIG shares, trading below $40 at the opening bell, climbed within 15 minutes to $41, then above $42. "This thing's going to $45," T3 President Marc Sperling said, watching his six computer monitors. "It's on every trader's radar screen across the country."
AIG shares rose 21% for the day, and T3's traders did "great," said Mr. Redler. Since Aug. 5, the shares -- deemed highly risky by most analysts -- have more than tripled. "The stock paid the traders' bills all summer," Mr. Redler said.
A year after the government sought to avert a market meltdown by rescuing some of the country's biggest financial firms, speculative traders are feasting on these companies' remains. Shares of two government wards, mortgage giants Fannie Mae and Freddie Mac, bounced between about 60 cents and $2 in August. Shares of Lehman Brothers, left to fail by the government and currently in bankruptcy proceedings, rose from five cents to 20 cents in recent weeks.
AIG, arguably, has been the biggest casino of all. In the past seven weeks, its common shares have careened between $13 and $55, surging past $54 on Tuesday before closing at $45.80.
The extraordinary price action is a dramatic display of an unintended consequence of the U.S. bailout of AIG. Last Sept. 16, the government propped up the faltering company by trading $85 billion in loans for an 80% stake in AIG in the form of preferred shares, which don't trade on the market. It allowed the other 20% of the company's equity -- its millions of common shares -- to continue to trade publicly.
Some analysts declared the deeply indebted company's common shares basically dead money. Many buy-and-hold investors bailed out. That has left AIG's common shares -- $6.2 billion worth, as of Tuesday -- trading most actively between short-term traders, who buy and sell based on market momentum and bet against each other in risky options trades. Often they use borrowed funds, amplifying their gains and losses.
Dominating the recent move in AIG stock were professional day traders like those at T3. But Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. also owned AIG shares during the run-up, according to people familiar with the matter. Fund managers including AllianceBernstein LP and Davis Selected Advisers also held the shares during a portion of the run-up, according to fund documents.
Taxpayers aren't profiting, or taking a hit, from the movement in AIG's common stock. That's because the securities the government owns, preferred shares, aren't traded. The government will recoup most of its investment if AIG can repay its debts through asset sales or profits. While a run-up in common shares would typically reflect an increase in expectations of a company's overall value, in this case, AIG has to repay roughly $80 billion before holders of common stock can expect to see their share of profits.
Alex Herrera, head of Soldier Capital LLC, a 26-member day-trading firm in Ramsey, N.J., has been among those buying and selling AIG. A former floor trader on the New York Stock Exchange, Mr. Herrera says he often trades blocks of 100,000 shares, using funds he borrows through the firm to make bets of as much as 15 times the size of his portfolio.
On some days during the past month, AIG trading volume topped 130 million shares -- nearly equaling the total number of existing common shares -- up from less than 10 million a day in early August. Trading by firms such as Soldier Capital is "one of the reasons you're seeing all this volume," says Mr. Herrera, 40 years old.
Seeds of a Run
The U.S. bailout of AIG on Sept. 16, 2008, followed by two additional rounds of government assistance, had most investors leaving the stock for dead. Trading volume dried up. Common shares, which surpassed $100 before the AIG meltdown, changed hands below $2 apiece.
The seeds of the recent run were sown on July 1. AIG did a "reverse stock split" in which 20 shares became one. Such a split typically attracts investors. It would also potentially guard against having the stock delisted from the New York Stock Exchange if its price went too low for too long.
The conversion changed the share price from $1.16 to roughly $20 a share. It didn't, however, change AIG's prospects for quickly repaying the government.
In the days after the split, traders like Kenneth Glick started betting the shares would fall. Mr. Glick, 37, works for Bear Capital Partners, a tiny day-trading outfit that operates from windowless offices in lower Manhattan in a building where employees often hike up four flights of stairs when the elevator is broken.
Staring at his computer, flanked by a wall-size print of reggae singer Bob Marley, Mr. Glick shorted roughly 2,000 shares of AIG, selling borrowed shares with the intention of replacing them with cheaper shares if the stock declined. Like most day traders, he didn't hold onto his short positions overnight. He says he made about $1,000 from AIG trades in the week following the split.
On July 9, he posted a video on YouTube. "AIG shouldn't even be a stock," he said, calling the company "finished." In the video, Mr. Glick disclosed that he was shorting the stock.
But the bulls prevailed. The next day, AIG closed at $11.74, up more than $2. On a Yahoo message board devoted to AIG, anonymous posters said the shares were heading up -- with one predicting a $300 share price in three years.
By mid-July, AIG's stock had become a tinderbox. Professional traders watch message boards as a barometer of investor sentiment, and monitor stocks for changes in buying patterns. Should the share price begin to rise, they believed, the many speculators who shorted the stock would have to buy the shares they had pledged, sending prices even higher. One more surge in AIG shares would ignite a fierce rally, traders say.
That spark came on Aug. 5, the day after AIG named a new chief executive, Robert Benmosche, a retired banker and insurance executive with a solid reputation in the insurance industry.
Within the first two hours of trading, shares surged 25% to $17. On message boards, posters speculated that former American Express CEO Harvey Golub would join AIG. (He later did, as the board's nonexecutive chairman.) There was talk on trading floors that AIG and the U.S. would strike a deal to cut down the debt the company owes the government.
The latter hasn't materialized. But AIG's shares closed up 60% on the day, at $22.
A Revival in Options
The jump in share prices spilled over into the market for AIG options, which had been moribund. Most of the trading was in call options, which allow the buyer to pay a small premium in exchange for the right to buy a stock on a particular date at a specified strike price.
Trading volume in AIG options exploded on Aug. 5 to 380,000 contracts, up from 10,000 or 20,000 in prior weeks. Trading was especially heavy in out-of-the-money call options, where the strike prices -- ranging from $25 to $35 -- were far above AIG's current share price. In other words, buyers of such contracts were betting on big price jumps.
The strategy promised big profits. Traders who bought the August $30 calls on Aug. 5 could have more than doubled their money by the time the contracts expired.
The activity magnified price gains in AIG shares. That's because options dealers whose contracts required them to deliver AIG shares at a higher price bought more AIG shares to hedge their bets.
Some day traders and brokers took bigger risks. They sold such options naked -- without buying the stock they might be required to provide should AIG shares hit the strike price. It was a risky bet that the shares would fall.
Among those who made these wagers was William Lefkowitz, an options strategist at vFinance Investments in New York. On Aug. 5, he says his phone lines were jammed with calls from clients.
"I'd put someone on hold to finish a conversation with a client who wanted to buy [options on] AIG. By the time I got back to the first client the stock would have jumped three points," he says. "It was amazing -- a dream for a person who wanted to trade."
Mr. Lefkowitz says he believed the stock would decline, so he proposed a bearish play: His clients would sell call options with the hope that they would pocket the buyer's premium if the underlying stock failed to reach the strike price. He made the same bet personally. Like many of his clients, he sold the options naked.
"You want to do this when the stock is going up and things are exciting," says Mr. Lefkowitz. In this case, the risky play worked: The options expired before AIG shares hit $50, letting Mr. Lefkowitz pocket a fast $500 without having to deliver the stock.
Sitting on the Sidelines
More traders chafed to get in. At Nine Points Management & Research, a hedge fund whose investing style involves jumping in after a stock catches fire or breaks sharply lower, manager Damon Vickers rued sitting on the sidelines. "It was ridiculous we missed the first move," Mr. Vickers recalls saying in an August huddle with his partners. "This is what we watch for."
On Aug. 20, AIG shares surged anew amid bullish comments from the new CEO, Mr. Benmosche.
The rally created a panic for traders who had sold naked call options on AIG shares with a $30 strike price, believing the stock never would hit that level. Now these players scrambled to buy AIG shares so they could meet their obligations. This drove shares still higher.
The rising price attracted more people who bet the stock would fall. On Aug. 20, 12.5 million shares were sold short through the Nasdaq -- 47% of the exchange's AIG volume. But shares kept rising, closing above $32.
Mr. Vickers, meanwhile, got his second chance. The fund manager grabbed the stock on Aug. 26, when AIG shares rose to nearly $38 from $34. The next day, in a moment that hearkened back to the fervor of the technology-stock boom, the fund manager appeared on television, predicting that AIG shares could hit $300.
The chat rooms were jammed with investors trying to decipher what was happening. "Did CNBC say $300 per share?" read one comment.
As the stock moved toward $50 on Aug. 28, messages grew frantic. "Buy, BUY, BUYYYYYYY!!!! AIGGGGGGG," read one. "Shoot for the $77 today with [impending] News," read the next message on the same board.
That day, trading volume in AIG shares soared and the stock hit a closing high of $50.23.
On the options market, traders began betting that the stock would fall in coming months, possibly even back to single digits.
By Sept. 1, AIG shares had sunk to $36. Mr. Vickers at Nine Points says he got out at a small profit.
Manhattan day trader Mr. Glick, once bearish, began buying, darting in and out of AIG over the course of the day. By mid-September, he had lost most of the $1,000 he made earlier shorting the stock. "AIG has caused me nothing but heartache and pain," Mr. Glick says now.
Others have kept churning. On Monday, the day a government report raised doubts about AIG's ability to repay its debts, shares nonetheless surged 22%.
The run continued Tuesday, with shares reaching $54.40, near its August high. But after noon, commentator Jim Cramer wrote on TheStreet.com that AIG should do a secondary stock offering to help repay the government. Rumors swirled that the company could use its higher share price to raise cash at the expense of current shareholders. Shares plummeted, closing at $46.50.