Monday, September 14, 2009

Why I Just Shorted AIG

I've been looking for an opportunity to put to work our New Leading Indicator (or - should I say - potential indicator. That's what that “putting to work” phrase is about.)

In markets, you can paper trade and speculate “out of the game” all you want. That's great for the first short stint, but the real learning comes from rolling up your sleeves and getting dirty. Having to live through those first few times (and probably many to follow) of bi-polarism that the market so naturally induces in all humans. Of nail-biting excitement as your buys rally up, up and away! Or that gut-wrenching feeling as you watch those hard-earned dollars burn out with every down-tick.

But that is where the real learning happens.

Any theory is great (in theory) if proven using past data. Any idea can be justified, any concept empirically “proven” (just look at how our government puts out its statistics, and what their REAL counterparts actually look like).

It's putting them to work that tests their mettle. Most theories fizzle out pretty quickly – the flaws become apparent sometimes on the first attempt. Those that don't fade often require radical change.
And then there's the bigger point.

The market is a different beast than most places where theories are tested.  The market is not a controlled lab - there are no rewrites or backup prototypes.  If you flub the idea that money is gone, those moments or market action are gone.  Sometimes licking your wounds is the most learning experience of them all.  In markets all you have is the now, which quickly becomes the past-to-be-studied.

To truly test a market theory, you do it in real time. You do it so you have to fight away the emotions, actually pick stop-outs and targets and actually USE them. You do it to see if this idea gets framed and stamped above the mantle, or if it gets tossed to the flames below.

Which is where we come to now. Test numero uno. And, I suppose, where the title of this article gets its genes from.

Here's the skinny:

Ahh, yes,” you say.

Our New Leading Indicator (I have yet to come up with a name for it – the combination of price action, RSI action, and MFI to find potential reversals ahead of time – any suggestions fire them my way!). 

It has indicated (no pun intended!) a higher probability of smart money entering into a long position during the huge plunge and consolidated price action. This was followed by a sharp rally to over $55.00 per share.

Before that point the money started flowing out of AIG, potentially indicating the smart money winding down long positions and switching to short positions. Now we have a semi-down-trend starting to form and a slowly and surely decreasing MFI along with it.

It would seem that the optimal exit point for this trade would be when the MFI hits 20 or lower indicating a short-hammer on the stock. Kind of like last time it did this.  Not to mention this is all under the backdrop of a very bullish short-term market.

I am not going to get too technical about all of this, because this is a conjecture and a first trade, and instead of actually short selling the stock itself, I opted to buy $40.00 November Puts for $9.50 / pop x 2 contracts (a sample, so to speak).

If we DO see a re-occurrence of the price retracement as we saw in AIG in mid-July, there is the potential for at least 100% returns on these Puts.

I am not expecting to make a new low here – as you can see I have drawn a trend line to pick a rough exit point. I will close out my trade on two possible conditions:

  • MFI is greater than 20 but the price is at or below the trend line intraday.

  • MFI is 20 or lower but the price is still above the trendline.
Since the volatility on this stock is huge and 60 days is a long time in terms of AIG trader activity, I will set a stop out on the following condition:

  • The price of AIG closes higher than the intraday high set in late August. I will sell the Puts for whatever they are worth on the following trading day.

We'll see over the coming few weeks whether our New Leading Indicator is off to the races or flops down dead.


Full Disclosure:  Wouldn't You Know it, I'm Short AIG!


  1. Derek;

    What did you do on this trade??

  2. Actually I was just going to write a follow-up article on this one in the next couple of days.

    Unfortunately the options themselves did not retain as high a time-premium as I had hoped and were sold for a 27% loss. However if one had simply shorted the stock (requiring a much greater amount of capital mind you), the return on investment on the date of sale (Oct 26) would have netted a 30% gain in a little over a month.

    The goal of this exercise continues to be to find counter-trend indicators which will allow for leveraged-gain possibility using call or put options with a mid-term 1-3 month time horizon.

    Unfortunately due to the volatility of AIG the time premium was very high off the hop and shrunk drastically as price action leveled off over a couple of weeks. On a less volatile stock with a solid trend reversal the potential for gains could be very promising, somewhere in the 100% + range.

    It is something I plan on investigating further in the future.