Option Traders Appear to beBullish on Financial Stocks

Looks like most traders were expecting bank stocks to rise when earnings reports are released. Calls outnumbered puts by more than 2-to-1 yesterday on the XLF exchange-traded fund. The following article by Doris Frankel from Reuters takes a look the numbers and what they mean.

Option traders appear to be stepping up bullish positions in an exchange-traded fund tied to a basket of financial stocks just ahead of a slew of earnings from big U.S. banks.

Shares of the Financial Select Sector SPDR exchange-traded fund XLF which tracks financial-related companies from the Standard & Poor’s 500 index rose 1.9 percent to $15.49 on Thursday.

The rise in the fund was accompanied by a burst of activity in its calls, contracts often used to bet on share gains, in a change of sentiment from the previous session. It comes a day before bellwethers JPMorgan Chase & Co and Wells Fargo kick off bank earnings Friday morning.

“Today’s call buyers are possibly anticipating additional short-term strength in the financials heading into earnings reports from JP Morgan and Wells Fargo tomorrow morning,” said WhatsTrading.com options strategist Frederic Ruffy.

Traders exchanged a total of 132,000 calls and 72,000 puts in the XLF, below its recent average daily volume of 345,000 contracts, according to options analytics firm Trade Alert.

Many investors reached for the May $16 call strikes, where transactions suggested extended gains in the fund’s price by expiration in 36 days. In all, more than 66,600 contracts traded in that strike, with 95 percent of the activity on the ask price, indicating they were bought, data from Trade Alert showed.

“The call buying in the XLF, notably the May $16 strike calls, looks to be a bullish bet on positive developments on the banks from their upcoming earnings,” said C.C. Lagatore, a co-founder of RiskReversal.com, an option trading website.

Data from brokerage firm TradeMonster showed 61,000 May $16 calls were bought for 18 to 20 cents per contract during the session. Call owners would turn a profit if the fund rises above the $16.20 break-even price by expiration.

“The high in the XLF last year was just above $17 prior to the European debt crisis bubbling up,” Lagatore said. “It appears that traders are positioning for a run at last year’s highs.” But he noted this type of trade can be used as protection against a short position in the shares of the fund.

Calls are often used to bet on share price appreciation as well as to hedge a short position in the underlying security. They grant investors the right to buy shares at a fixed price any time up until expiration.

The May $16 contracts in play were more than one-third of its open interest, making it hard to tell whether traders were initiating new bullish bets or buying to close existing positions.

“Our take is that this call buying reflects optimism about JPMorgan and other large constituents of the XLF,” said Jon Najarian, a co-founder of brokerage firm TradeMonster.com.

Other components of the fund include Citigroup Inc , Goldman Sachs Group and Bank of America Corp , all reporting results in the coming days.

For 81 financial companies in the S&P 500 stock index, first-quarter earnings are expected to be up 6.5 percent from a year ago, according to surveys of analysts by Thomson Reuters I/B/E/S through April 4.

The interest in the fund’s calls was a key shift in sentiment from Wednesday when 165,000 puts and 48,000 calls traded in the XLF. The April $15 strike puts on the XLF were the most active on volume of 126,900 contracts with an early seller and a late buyer, suggesting both bullish and bearish views.

One interesting development is that options implied volatility, which measures the expected magnitude of future share price movement in the XLF and individual banks, is historically low heading into earnings.

“This indicates that the option market is not pricing in big moves for the shares in banks in response to earnings,” Lagatore said. “For example, JPMorgan options are pricing about 2.5 percent move for the shares post-earnings based on the weekly options that expire this Friday.”

See Yahoo News for the entire article

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