AIG Chicanery of 8/5/09

On Friday, August 7th, AIG reported a return to profitability for Q2 2009 with an EPS of $2.30, following six successive quarters of loss. In a Friday press release, AIG attributed the positive earnings to a combination of the revaluation of assets due to accounting rule changes and agreements with the Federal Bank of NY to exchange debt for preferred shares in business units (ALICO/AIA) that are earmarked for future sale.

Common shares of AIG closed at $27.14 on Friday, for a gain of $4.61 or 20.5%. Personally, I have my suspicions regarding the validity of AIG's claims, but I'm in no position to make an educated assessment, as I have not delved deeply into their financial statements and have no intention of doing so. I don't trade AIG and until recently I excluded major TARP recipients from my trading radar, as a matter of course. If investors want to take AIG at its word, it's their prerogative.

What I do have a serious problem with is the events of Wednesday, August 5. On Wednesday, AIG opened at $13.64 and rocketed to a close of $22, constituting a one day gain of 62%. The stock's volume was 134M shares compared to 7.9M on the previous day representing a 17x increase, as indicated in the following chart (red emphasis is mine):

On Monday, 8/3, it was reported that Robert Benmosche was elected as the new CEO, but the stock showed little response. On Wednesday, 8/5, there was no news regarding AIG, nor were there any SEC filings. In fact, the most informative story on 8/5 was by the WSJ, titled: Why Is AIG Stock Up 63% Today? , in which the WSJ provided all sorts of implausible excuses for the runup. At least the WSJ acknowledged the runup, most business media ignored AIG stocks's second largest daily move in the last 25 years.

While the prospect of a one day gain of 62% sounds lucrative, it's not. Relatively speaking, it's chump change compared to the returns provided by the derivatives markets (relative return rates are above each bar):

Thus, if at 9:15AM on 8/5/09 you were holding 100 AIG HW August 25 calls, your position would be worth $600. Seven hours later, that same position could have been closed for $25,400 for a return of 4,133% and with the judicious use of trailing stops the return could have been closer to day's high of $3.00. This is the equivalent of dunking on Shaquille O'Neal, checkmating Gary Kasparov, and sleeping with God's wife, all in the same day. In other words, it can't happen. Yet, judging by the heavy options volume on 8/5, it very much did. I'm curious as to who made those OTM long call trades early on 8/5 and why we haven't heard from those who took the other side.

At the risk of appearing hyperventilatory, I believe that Occam's razor is readily applicable: AIG's 62% price runup on 8/5 can be attributed to the dissemination and systematic exploitation of insider information. The 1596% increase in volume clearly indicates that this can only involve large, institutional investors and that they are sufficiently secure in the SEC's impotence and the public's ignorance to make such a brazen move. Some might ask: Where are the cops? There aren't any and this is precisely the point that I'm trying to make. If you are trading in these markets, be aware of how far the House is willing to go press its advantage it and plan accordingly.

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