Call option volume in Financial ETF swells

16:27 28Aug2008 By Doris Frankel

CHICAGO, Aug 28 (Reuters) - The raucous debate in the options market over the outlook for U.S. financial stocks reached a fevered pitch on Thursday as trading surged in the main exchange-traded fund tied to the sector.

The volume of call options traded swelled in the Financial Select Sector SPDR fund, in what would typically be seen as a sign bulls were laying down bets on a recovery in the sector hit hardest by the year-old credit crisis.

Yet some option experts cautioned against taking that activity at face value because a hefty portion of that volume came from traders selling near-term call positions, a trade that may well be a bet on more trouble ahead for banks, brokers and insurance companies.

"At first take, the huge volume on the XLF could be interrupted as purely bullish on the financial sector. However, within that heavy call volume, some investors were taking advantage of the healthier premiums by selling call options," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group.

In all, roughly 935,000 call options traded in the XLF vs. 213,000 put options, double the normal level, according to option analytics firm Trade Alert.

Shares on the XLF, which holds financial-related components from the Standard & Poor's 500 index <.SPX> rose 4.04 percent at $21.39, above the 50-day moving average.

Financial stocks got a boost on Thursday buoyed by data showing the economy grew at a faster-than-expected pace in the second quarter and some positive company news.

Speculation in call options is evident in the XLF following an upward revision to U.S. gross domestic product, reports Lehman Brothers is planning further employee reductions, and news of a management shake-up at U.S. mortgage finance company Fannie Mae , said Scott Fullman, director of derivative investment strategy at broker-dealer WJB Capital Group.

Investors often buy equity calls, allowing them to purchase the company's shares at a given price and time, to wager on share price gains. A put conveys the right to sell the stock.

Call activity in the fund showed various plays and two-way traffic.

Option strategist Frederic Ruffy at WhatsTrading.com said it appeared a large call spread involving the September $22 and $23 strikes was sold early in the day.

If so, it was either a closing position or a bet that the fund will stay below $22 a share over the next few weeks into the September options expiration -- taking advantage of time decay through the weekend, he said.

Ruffy also noted some speculative call buying, particularly in the September $22 line, which is probably due to the strength in the sector.

"I think the XLF and the financial sector as a whole is forming a bottom and it is a good point to start buying either the shares or taking some bullish option positions," said Victor Schiller, president of options research firm Investors Observer.

(Reporting by Doris Frankel)