* Italy underperform peripheral peers amid volatility
* Spike in futures volumes points to speculative activity
* Lack of real money selling sign of long-term stability
By John Geddie
LONDON, May 21 Short-term, speculative traders have been behind this week's spike in Italian government borrowing costs, bond traders say, and the disproportionate concentration of activity in futures trade suggests the sell-off may be fleeting.
Over the last few trading days, analysts have been trying to understand the pressure that has sent Italian 10-year bond yields racing to two-month highs and doubled its borrowing premium over peripheral peer Spain.
Looming European parliament and local elections, underwhelming ECB monetary policy plans and controversial Greek taxes have all been blamed. But a spike in the volume of trade in Italian futures suggest this is mostly just short-term activity.
"In a way it is a good sign," said Luca Cazzulani, a strategist at UniCredit.
In three of the last four trading days, volumes in Italian government bond futures - a derivative favoured by hedge funds and propriety trading desks - have reached their highest levels since their launch in 2009.
Stress in futures markets affects the price of the underlying cash bonds, but traders and brokers say there has actually been little selling by cash bond holders.
Futures are traded on an exchange where data on volumes is freely available, while trading patterns in cash bonds are more opaque as transactions are done directly between two parties.
One broker speaking on condition of anonymity said commodity trading advisers, who implement investment strategies for hedge funds in futures markets, have been leading the selling.
Strategists say the fact that real-money bondholders have not been spooked by the recent price action suggests longer-term stability in Italian bond markets that should prevent a more sustained reversal in the recent rally.
"We suspect this is just a hiccup... It should end up as a healthy correction in the overall downward trend in spreads and outright yields for the periphery," said David Schnautz, interest rate strategist at Commerzbank.
While all peripheral bonds have been weak since last Thursday, the premium Italy pays over its peer Spain has doubled from 8 to 16 basis points, according to Tradeweb data.
Futures offer complex trading and hedging opportunities where investors can trade contracts to buy or sell bonds at a price specified today, with delivery and payment due in the future. They also allow speculators to bet on sovereign debt price falls without having to hold the underlying bonds, which is known as 'naked' short-selling.
As a result, BTP futures have become the instrument of choice for hedge funds shorting euro zone peripheral bonds since a ban on naked short-selling was introduced for European credit default swaps in 2012.
"You can find a very cheap way to speculate on peripheral bonds through this market," said Sergio Capaldi, a fixed-income strategist at Intesa SanPaolo.
A study by the International Swaps and Derivatives Association earlier this year noted that the average daily volume in long-term Italian government bond futures has increased by 101 percent since the ban came into force.
These futures are now the most actively traded liquid assets in peripheral government bond markets, but because they have become a medium for hedge funds to take negative views on the periphery, Italian bonds can suffer unduly.
"When you are in a rough time...a future can magnify the degree of volatility," said Intesa SanPaolo's Capaldi. (Reporting by John Geddie; additional reporting by IFR's Christopher Whittall; Editing by Hugh Lawson)