This past week saw financial sector dominate trading on the markets. In what has been dubbed "the dash for trash", many of the once doomed financial stocks surged to heights not seen since 2008. Is this simply the new bull market proclaiming the strength of the financial sector, or temporary euphoria before another market correction?

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Hank's Back
Leading the way late in the week was AIG (NYSE: AIG), which rose 26% on Thursday alone amidst rumors that former CEO Maurice "Hank" Greenberg may be on improved terms with the company he once built into the largest insurer in the world. Investors are hoping that Greenberg's vast experience and Rolodex of business associates may be able to help new CEO Robert Benmosche in returning the insurer back to prominence.

But a 30% jump in a single day and a 280% run over the course of a month has analysts wondering whether shares of AIG are benefiting from a short squeeze. Following their 20-1 reverse stock-split which drastically reduced AIG's float, short sellers have been frantically trying to cover their short positions. The reverse split has made that task much more difficult for short sellers increasing the stock's volatility thus resulting in this massive run-up in the stock price over the past 30 days.

The volatility won't settle anytime soon, as the reduced float combined with the extremely high open interest in the options market could see AIG shares yo-yo for the remainder of 2009. It's uncertain what to expect from AIG shares in the near term, so perhaps getting into a reverse calendar spread, which profits in volatile markets in the short-run would be a good play here. For those looking further down the road, opening a position in a LEAP would be another viable alternative for AIG.

Higher on Historic Volumes
Two other stocks that have seen a run-up, thanks to a huge increase in volume, are Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE), up 225% and 260% respectively for the month. This past week alone saw Fannie rise 75% with Freddie up 40%. Although the price appreciation is something to behold, it's the volumes that have caught everyone's attention. On Monday alone, trading on Fannie broke 830 million, with Freddie reaching 386 million. Considering that just a few weeks earlier trading volumes were in the single-digit millions, these volumes are historical. Some reports have these two stocks, along with AIG, Bank of America (NYSE:BAC) and Citi (NYSE:C) accounting for a phenomenal 35% of the NYSE consolidated volume since Aug 5.

With volumes on these "trash" financials heating up the scoreboards, it's obvious that retail and institutional investors alike are riding a wave of momentum that may well be creating another round of short covers in the coming days and weeks. If these stocks continue to trade higher on these kinds of volumes, shorters caught in the cross hairs could drive prices even higher. However, profit taking in the coming days will slow these financials down and bring some normalcy to the markets. Again, with so much open interest in the options market it's clear that people are betting one way or the other on where this recent super-rally is headed. My guess is Fannie and Freddie may have a little more room to run (10% or so), but profit taking will deflate these two GSEs by Labor Day. If you're looking to make a quick profit by speculating on a pull back, get into a leveraged bearish financials ETF like Direxion's 3x Financial Bear ETF (NYSE: FAZ). That being said, this ETF only makes sense as a day trade. A couple of up-days could compound your losses and eat up your position very quickly.

The Bottom Line
This past week saw financials benefit from high volumes and a possible short squeeze. With so much positive speculation in the sector lately, it might be a good time for contrarians to jump in and pick up some profits on the way back down. Then again, we've been waiting for a pull back for weeks now, and we have yet to see it. Perhaps the bulls will rule a little while longer. (For more, see The Industry Handbook: The Banking Industry.)

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