The wild ride for financial stocks lately has been triggered mainly by events on Capitol Hill and optimistic CEOs, but further fueled by hedge funds' bad bets.

There have been huge swings in high-profile financial names recently, with AIG ( AIG), Citigroup ( C), General Electric ( GE), Bank of America ( BAC) and Wells Fargo ( WFC) hitting months-long volatility heights, according to Bloomberg data.

During Thursday's session, AIG shares traded six times as high as a 33-cent low hit earlier this month, while Citi traded four times as high; BofA nearly triple; and Wells and GE both about twice as high as their March lows. All of the stocks closed lower, amid a broad market selloff.

The sharp rise in these stocks' value over the past month has burned hedge funds engaged in a newly popular arbitrage strategy -- if they didn't get out in time.

Those funds were shorting common stock while going long on other assets that are further up the capital-structure food chain, like preferred stock. Those assets are better protected in case of liquidation, and financials issued a bevy of preferred stock to the government in exchange for fresh capital. Citi and AIG preferreds were to be converted into common shares at prices much higher than the market rate, providing a double-digit differential as high as 20%.

As confidence in the financial system plunged in February, common stock followed suit, exacerbated by waves of short selling. By buying preferred stock, hedge funds were taking advantage of the differential between the conversion price on preferred shares at Citi and AIG, and the market price, which could be as high as 20%, according to one fund manager.

If you liked this article you might like

CEOs Are Dropping Like Flies

Downgraded AIG Isn't Finished Falling

Downgraded AIG Isn't Finished Falling

Former AIG CEO Greenberg Can Pursue Defamation Suit Against Spitzer

How to Make Easy Money on Apple's iPhone X Worldwide Reveal: Market Recon