AIG / SPY combo trade

9/16/08
AIG on the brink of bankruptcy or rocket up
SPY on the brink of a breakdown or rubberband like launch
bot +200 shares of AIG at 3.95

bot +1 SPY 122 PUT @4.50
bot +1 SPY 117 PUT @2.56
avg. 3.53

using spy as a hedge should be efficient as a AIG b.k. would mean a break down in the market (SPY).

scenario 1:
AIG goes b.k. US looses 116,000 jobs and the $1T in assets will be unravelled with God knows what kind of wrath.
I loose 3.95 x 200
I (should) win with the SPY atm and otm puts
The spy vix is at 30+ which allows for a large move, bigger than the cost of my 200 shares of AIG. That being said scenario 2 could be an easier win

scenario 2:
AIG gets funding and is re-established it finds its capitulation low and rockets back up 200% ++++
The spy can't possibly go down as many points as AIG can go up, therefore this scenario has the higher likelyhood of BIG profits.

scenario 3:
worst case is that the market finds some resolution and AIG gets some temporary reprieve some how or it doesnt rebound or fall as much as my Spy hedge therefore leaving me at a loss, the SPY vols will also influence the trade.

UPDATE 9/16:
in aftermarket trading the spy and aig contracts are trading in parity both down about 2 points.
Fed announced to offer the 85B to bail out and take 80% of the company

Update 9/17
next day market is slammed hard...UGLY!
SPY finishes the day making a new low..down $5.50 or 4.5%
AIG finishes the day down only 1.72 but equal to a 45% down move!
With respects to my trade this is a fantastic spread!
I closed out half of the postion and wait for maybe a furtherance of the move or sickening snap back, short covering explosion. This would possibly send AIG off to the moon while the SPY will not likely keep up with move creating a nice spread going the other way.

Trade results as of 9/17
200 AIG at 3.95 sold 100 for 2.12 = -1.83 (100 shares)
SPY 117 puts at 2.56 sold for 4.40 = +1.84 (100 share contract)
result is even...
WHY????
A 3.78 spread in the underlyings and a volatility boost in the SPY (helping my naked Put) didn't create a profit...
Well if I would of straight shorted the SPY and bought AIG this would of been true dollar for dollar, BUT b/c I bought 2 different put strikes and involved the greeks the deltas were not equal and therefore the moves didn't match up accordingly. If I were to of bought -200 deltas worth of SPY puts my outcome would of proven profitable.
Interesting lesson learned.
Lets look at the balance of the position as of the close today:
AIG at 2.03 = -1.92
SPY at 116.61 122 put at 7.75 = +3.25
You can see with the ITM put the deltas are more equal to the 100 shares of AIG and thus giving us a closer relation to the spread, also helping is the vega increase in the put contract.



*note AIG traded 1.2 BILLION shares today!!!

9/19
btc spy 122 put for 2.74 = -1.76 loss
AIG is currently trading at 5.39 = +$139
resulting in a unrealized loss of $40 or so.
I will continue to hold AIG throug this rockiness in hopes it will emerge and get back to double digits then close.

disclamer: this trade was a recommendation from 1option.com:
http://www.1option.com/index.php/global/comments/this_is_going_to_be_reolved_this_week_buy_aig_and_buy_spy_puts/