Bailed-out U.S. financial stocks surge

NEW YORK (Reuters) - The shares of companies bailed out by the U.S. government during the financial crisis surged on Tuesday, fueled by speculation about money-making asset sales, cheap valuations and a recovery.

Citigroup Inc (C.N) stock rose as much as 8.4 percent after a prominent fund manager said the bank's shares were underpriced. Citi shares closed 7.3 percent higher.

Insurer American International Group Inc (AIG.N) rose as much as 19.6 percent before closing 12.6 percent higher at $32.77.

And government-owned mortgage companies Freddie Mac FRE.N and Fannie Mae FNM.N were up as much as 18.5 percent and 15 percent, respectively. Freddie Mac closed 7.6 percent higher at $1.28 while Fannie Mae ended 5.9 percent higher at $1.07

"The markets have that emotional resilience of 'Hey, we're one year out of the abyss.' A lot of things have gone up just on the rising tide syndrome," said Ken Grant, a Partner at Waterstone Private Wealth Management in Owasso, Oklahoma.

"It's probably a little more optimistic than rational."

Web information site optionMonster.com co-founder Jon Najarian said government-owned stocks such as Citigroup, AIG, Fannie Mae and Freddie Mac rallied in contrast with Goldman Sachs Group Inc (GS.N), JPMorgan Chase & Co (JPM.N) and Morgan Stanley (MS.N), which are not government-owned and closed lower.

The U.S. Securities and Exchange Commission denied rumors it is considering curbing short sales on companies in which the government owns stakes, which some analysts cited as a reason for the rising stocks.

AIG option volume was five times greater than normal, with about 223,000 calls and 98,000 puts traded, according to option analytics firm Trade Alert.

AIG call option action was scattered across the front-month March contracts with strike prices ranging from $22 to $45, Reuters data show.

Cantor Fitzgerald & Co's director of institutional derivatives sales and trading, Mike Khouw, said such activity could be a signal investors are buying AIG calls to hedge a short position or make a bullish speculative play.

"There is a lot of chatter now that AIG is going to have more asset sales coming up relatively shortly," Khouw said.

Jud Pyle, chief investment strategist at Options News Network, a division of option market making firm PEAK6 Investments, said the Citi rally is causing investors to wonder if AIG might see increased proceeds from its remaining assets and that a government stake could be working to the companies' advantage.

"If there is speculation that the stocks have been held down too much by that potential overhang, then that could be another reason for the rally," Pyle said.

AIG said its policy is not to comment on unusual market activity.

AN IMPROVING BALANCE SHEET

In an interview with Fortune, Fairholme fund manager Bruce Berkowitz argued Citigroup's balance sheet is improving, the bank is well capitalized and the stock is trading at a lower valuation than many of its peers.

"The price is right," Berkowitz told Fortune. "It's just a question of when it becomes obvious to everyone that the worst is over."

Berkowitz, who calculated that even Citigroup's bad assets now return more than 5 percent, manages $11 billion at Fairholme, Fortune said. Morningstar recently named Fairholme a top fund manager over the last decade, the magazine reported.

Separately, the U.S. government is considering shedding its 7.7 billion Citigroup shares over the next few months, according to Fox Business Network's Charlie Gasparino. Previously, investors thought the United States would look to sell over the course of the year.

Jon Diat, a spokesman for Citigroup, declined to comment, as did a U.S. Treasury spokeswoman.

The U.S. government is eligible to start selling its stake of about 27 percent in the bank later this month.

Citigroup shares rose 26 cents to close at $3.82 after trading as high as $3.86. Those prices are well above the $3.25 level at which the U.S. government bought the shares.

Citigroup option trades were heavy, with overall volume of about 1.71 million contracts, six times greater than usual, Trade Alert figures show.

The volume was led by the trading of 1.43 million call option contracts where the bulk of the activity was in the $4 Citi call strikes that expire in March and April.

(Reporting by Dan Wilchins and Clare Baldwin in New York and Doris Frankel in Chicago; editing by Richard Chang, Gary Hill and Andre Grenon)