* Ban is due to lapse by Friday
* Stocks have soared, bond yields fallen, since July turmoil
* Big banks have outperformed the wider market
By Rodrigo De Miguel
MADRID, Jan 28 (Reuters) - Spain may end its ban on short-selling stocks and bonds this week as the euro zone crisis relents, although controls could stay for bank shares which speculators targeted heavily during last year's turmoil.
The National Securities Market Commission (CNMV) has to announce by Friday whether it will extend the ban, which was imposed in July during a massive sell off in Spanish sovereign debt and shares.
Stocks and bonds have since rallied following a European Union-financed rescue for troubled banks, and Spanish lenders are now finding it easier to raise funding on the markets.
A CNMV spokesman declined to comment on what the agency will decide. But with sentiment on Spain vastly improved, analysts believe the ban on short-selling - when an investor bets that prices of an asset will fall - can now safely lapse.
"They have no reason anymore to maintain this ban. The debt risk premium is less volatile and that may be the right time," said Ivan San Felix, analyst at Renta 4 brokerage.
The IBEX blue-chip index has soared 40 percent since July, while the risk premium on Spain's 10-year benchmark bonds over comparable German bonds has fallen by 300 basis points since its July peak of 640 basis points.
Many Spanish stocks have hitched a ride on the sovereign spread reduction, soaring as the government took advantage of sinking borrowing costs to sell billions of euros of bonds in January and complete 14 percent of its 2013 fund-raising needs.
The short-selling ban was originally imposed for three months and was renewed in October for the same period, which ends this week. Italy, France and Belgium have already lifted short-selling limitations introduced at the same time. Only Spain and Greece continue to restrict the practice.
A new EU short-selling law came into force in November, so short-sellers know that the European Securities and Markets Authority, or ESMA, can step in rapidly in a coordinated way in the future in case of speculative attacks.
Short positions on the 20 most heavily shorted Spanish stocks fell to 1.8 percent of the companies' capital in mid-January from 3.1 percent in July last year, as investors covered positions, one analyst said, asking not to be named.
Spain's mid-sized banks were among the stocks most affected by short-selling before the ban. Short positions in Bankinter represented 6.19 percent of its capital in late July, and have now fallen to 3.5 percent, according to CNMV data.
Those in Banco Popular fell to 4.17 percent of its capital as of November from 6 percent in July.
Exane BNP Paribas said in a research note that the companies that could be most affected by short-selling after the ban is lifted are Bankinter, wind farm company Acciona, large bank BBVA and wind turbine maker Gamesa.
This is based on their recent outperformance of the wider market and the fact that they have enough liquidity for short-sellers to be interested in them.
In a short sale, an investor borrows financial instruments and sells them, in the hope of buying them back later at a lower price and booking a profit before returning them to the original owner.
Other analysts said the decision to renew the ban last October was partly due to plans by Banco Popular, a systemic lender in Spain, to raise more capital.
Since then, the financial sector has received 40 billion euros in European aid to tackle the damage from the bursting of a decade-long real estate bubble.
"We believe the ban will be lifted because our view is that it was renewed to avoid any speculation and any problem around Popular's capital increase," said Soledad Pellon, market strategist at IG brokerage. "There is no reason (to enforce the ban) anymore and the market is ready."
Another option for CNMV could be to lift the ban on everything apart from banking stocks, analysts say.
This would help to protect the biggest banks from a sharp drop in their shares, which have soared since last July, although speculators could simply target other sectors.
"Short-sellers would get into the building sector and that would be unfair," said Pellon.