Is it Finally Time for Financial ETFs?

Two ETFs allow traders to bet both sides of beaten down banks

By Jim Woods, Editor-in-Chief, Successful ETF Investing, Stock Investor's Blueprint

Sellers have feasted on financial stocks in 2011, as the performance of the sector’s premier exchange-traded fund (ETF) clearly demonstrates. The Financials Select Sector SPDR (NYSE: XLF), an ETF that holds the biggest banking and financial companies, is down 8.4% year to date. That’s pitiful when compared to the broad market, and despite the last six weeks of selling, the S&P 500 Index still is up 1.4% year to date. The XLF may not be doing too well but it is arguably one of the best ETFs for this sector.

The divergence between financial stocks and the general market has some bargain hunters eyeing the sector. Attractive valuations, boosted dividends and support from iconic investor Warren Buffett are all reasons cited in support of the banks. The only problem is that price never lies, and despite the aforementioned positives, the mood of investors in the sector remains morose. The good news is that often means opportunity for options trading investors.

The chart here of XLF — which counts banking behemoths JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC) and Citigroup (NYSE: C) among its top holdings — shows a violent plunge below long-term technical support at the 200-day moving average. Financials haven’t been this low since December, and many are wondering if stocks in the space are headed below the 52-week low set in September.

A look at the options market for an indication of which way traders think financials are headed doesn’t really give us a clear picture. Volume in the out-of-the money XLF Aug 15 Call (a bullish bet) is running about the same as volume in the out-of-the money XLF Aug 14 Put (a bearish bet), so there seems to be equal sentiment on both sides of the aisle as to the future of financials.

One thing we can say about the sector with certainty is that these stocks are subject to a lot of volatility, and as such they can move swiftly in both directions. The recent drop in XLF from its February peak through the present clearly shows that. On the flipside, the nearly three-month surge in the space from December through February shows the power and profit potential these stocks present investors.

Bulls betting on the bargain potential of financial stocks can either buy XLF, or buy call options such as the aforementioned XLF Aug 15 Call. Sector bears can bet on a continued decline in the shares with that XLF Aug 14 Put. Also, those who remain unconvinced that the banks will bounce from here also can short the sector via the ProShares Short Financials (NYSE: SEF).

This ETF is designed to deliver the inverse performance of stocks in the space, and as such it’s the one you want if you feel financials will continue to falter.

As of this writing, Jim Woods held no positions in the funds mentioned in this article.

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