Today, large tranches of near-term out-of-the-money (OTM) call options have traded in American International Group (AIG) stock, the $50 billion market cap insurance company. This serves to highlight how cheap the stock is now.
AIG stock is down recently and is trading at $71.67, down from $77.41 a month ago on March 21. As a result, these call options show that some investors are bullish on the stock and hope to see it rebound. On the other hand, short-sellers of these OTM calls are happy to collect the income in these short-term naked short-call or possibly covered-call plays.
The Barchart Unusual Stock Options Activity Report today shows that 2 large tranches traded in AIG stock, as seen in the table below. Both expire on May 3, not only about two weeks from now but also one day after the company reports its Q1 earnings on May 1.
Each one of these tranches is at different strike prices for significantly higher premiums in the near-term strike price.
Making Money on the Calls
The $75 strike price has a premium of 95 cents on the bid side. That means the long holder of these calls hopes to see AIG stock rise over $75.95 by May 3. They expect the earnings call to show good results and the stock will improve. On the other hand, the short-sellers of the calls are collecting a nice yield of 1.267% (i.e., $0.85/$75.00). They will not mind selling the stock at $75.00 if the options get exercised. That highly implies they could be covered-call short-sellers of these call options.
They show that a large volume for each tranche was traded. For example, the $75 strike price tranche has over 5,000 option contracts traded. That is 24 times the normal outstanding interest in those calls. That highly implies that the short-sellers are likely institutional traders.
For example, they could have bought the stock today at $71.66 and collected the 95-cent (per contract) income. That lowers their buy-in cost to just $70.71 before commissions. So, if the stock is called at $75.00, they can make a 2-week profit of 6.067% (i.e., $75/70.71-1). If this can be repeated every two weeks for a quarter that works out to an expected expected return (ER) of 26.56% on a compounded basis.
The $80 call option has 5,000 contracts traded as well, or over 40x normal outstanding interest. That call option is further out-of-the-money. The call option holder stands to make much more if the stock rises over $80.15 by May 3, but it is more risky. The short-seller is making much less income. However, it's less risky for them, as selling AIG stock at this price, if exercised, could provide a higher potential capital gain.
The bottom line is that either way, these call options serve to highlight how undervalued AIG stock looks right now.
AIG Stock Price Targets
Analysts now project earnings per share (EPS) this year will reach $6.99 and $7.97 next year. That means AIG stock is on a forward P/E multiple of just 10.3x this year and 9.0x times next year. That is very cheap.
Moreover, the company pays an adequate dividend of $1.44 per share, which it has kept level for the past 4 quarters. That implies that there is the possibility the company could raise the dividend this quarter. Either way, the stock has a good dividend yield of 2.0% (i.e., $1.44/$71.91).
As a result, analysts have significantly higher price targets for the stock. Yahoo! Finance shows that the average of 16 analysts is $78.35 per share, or 9% higher. That still leaves the stock at just 10x next year's EPS projections.
Moreover, Anachart.com, a new-side analyst stock recommendation service, shows that the average of 18 analysts is $84.15, or 17% higher. In other words, the stock looks very cheap here.
The bottom line is that call options in AIG stock that expire after its upcoming earnings release serve to highlight how cheap AIG stock is right now. Whether buying or shorting the calls at these levels, it looks like investors have a good way of making money.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
