Bearish Bank Bets at Six-Month Low on Stimulus Optimism: Options

Options protecting against losses in U.S. financial shares have fallen to the cheapest level in six months amid speculation policy makers’ stimulus measures will extend this year’s rally in bank stocks.

Puts that pay if the Financial Select Sector SPDR Fund (XLF) falls 10 percent cost 7.2 points more than calls betting on a 10 percent gain, according to data on three-month options compiled by Bloomberg. That’s near the lowest level since March and down from 11 points on May 23.

Investors are growing more confident on financial shares, the best performing industry in the Standard & Poor’s 500 Index this year, as European leaders work to tame the region’s debt crisis. The U.S. exchange-traded fund, which tracks companies such as Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM) and Berkshire Hathaway Inc. (BRK/A), has gained 21 percent since its June 4 low. The Federal Reserve said today it will buy mortgage securities to bolster the economy.

“It’s about easing tensions in Europe and increasing possibility for further quantitative easing in the U.S., which bodes well for financial stocks,” Brian Jacobsen, who helps oversee about $209 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said in a phone interview yesterday.

Implied Volatility

Implied volatility for three-month contracts with an exercise price 10 percent below the financial ETF fell 12 percent this month to 23.71 yesterday, data compiled by Bloomberg show. The key gauge of options prices slipped 9.1 percent to 16.5 for calls 10 percent above the fund, which is known by its XLF ticker symbol.

The price relationship known as skew fell to 6.63 on Sept. 10, its lowest level since March.

Chairman Ben S. Bernanke and his colleagues said today the Fed will expand its holdings of long-term securities with open- ended purchases of $40 billion of mortgage debt a month and hold the federal funds rate near zero “at least through mid-2015.” The central bank’s policy-setting committee said it will continue its purchases and undertake other efforts to help the labor market if the outlook for employment does not improve.

Central banks around the world are taking steps to support economic growth. The European Central Bank on Sept. 6 announced plans to buy an unlimited amount of bonds of the most indebted nations in the region to suppress borrowing costs for struggling governments.

‘Question Mark’

Lenders such as Citigroup Inc. (C) are laying off employees as they adjust to new trading restrictions and as clients take fewer risks, threatening profits. JPMorgan could still lose more money on investments from its London chief investment office even though the bank has “mostly fixed” the problem, Chief Executive Officer Jamie Dimon said this week.

Congress tightened oversight of banks, overall financial stability and consumer protections by passing the Dodd-Frank Act in 2010. The Fed has raised capital standards for the largest banks, subjected them to annual stress tests and boosted scrutiny of their lending and trading practices.

“Regulation remains a question mark for the financials,” Robert Pavlik, who helps manage about $1.4 billion as chief market strategist at Banyan Partners LLC in New York, said yesterday in a phone interview. “That combined with the immediate risk that the Fed doesn’t do anything or doesn’t do enough in the eyes of the market to improve the interest-rate environment for banks.”

VIX Declines

The Chicago Board Options Exchange Volatility Index, known as the VIX (VIX), fell 11 percent to 14.05 today, its lowest level since Aug. 20. Europe’s VStoxx Index, which measures the cost of Euro Stoxx 50 Index option prices, lost 0.6 percent to 23.51.

The ratio of outstanding puts to sell the financial fund versus calls to buy dropped 39 percent since its high a month ago to 1.18-to-1 on Sept. 10, the lowest level since May, data compiled by Bloomberg show. October $16 calls, with an exercise price 1.7 percent above yesterday’s close, were the most-owned among all of the ETF’s options. Their open interest increased by 300,113 contracts since Aug. 13 to 307,757 on Sept. 11.

“It looks like traders are placing shorter-term bullish bets on XLF,” Steven Williams, chief derivatives and exchange- traded product strategist at Rosenblatt Securities Inc. in New York, said yesterday in an interview. “All the financials look strong.”

To contact the reporters on this story: Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net; Andrew Rummer at arummer@bloomberg.net

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