October 11, 2017 / 8:17 PM / a year ago

Bullish flows into financial ETF belie worries ahead of bank results

NEW YORK (Reuters) - Recent options market activity shows traders have turned less bullish on a key financial sector exchange-traded fund, analysts said, just ahead of earnings reports from some of the largest U.S. banks.

Concerns about trading revenues have taken the shine off a bank share rally fueled by bets of another Federal Reserve interest rate hike this year, leading investors to dial back bullish options positions on the Financial Select Sector SPDR Fund (XLF.P).

JPMorgan Chase & Co (JPM.N), Citigroup Inc (C.N), Wells Fargo & Co (WFC.N) and Bank of America Corp (BAC.N) are among the fund’s top holdings and all report third-quarter results over the next two days.

“Back in September we had a lot of call buying and the bullish interest continued into this month,” said Ilya Feygin, managing director at WallachBeth Capital in Jersey City, New Jersey, referring to options giving the holder the right to buy the ETF’s shares at a set price.

“But recently we have seen more profit taking.”

Some traders have either closed bullish positions outright or rolled them forward to longer-dated expirations, pocketing recent gains in both cases.

The SPDR financial fund has pulled in a net $2.36 billion over the last month, the most among all S&P 500 sector ETFs, according to data from ETF.com.

The fund is up 13 percent year-to-date, with much of that gain coming after the Fed’s Sept. 19-20 meeting, where the U.S. central bank kept interest rates steady but signaled at least one more rate hike by the end of the year.

The gap between longer-dated and shorter-dated U.S. Treasury yields has widened over the last month, resulting in a steeper yield curve.

That could benefit bank profitability since a steeper yield curve allows banks to borrow at lower short-term rates and lend at higher long-term rates.

But a steeper yield curve may already be reflected in bank share prices, and investors could be quick to react to any earnings surprises after such a strong rally.

“I think (higher rates) is already priced in,” said Feygin. “The next move in the sector is to underperform the broad market.”

Record-low equity market volatility has weighed on U.S. banks’ equity trading volume. The CBOE Volatility Index .VIX logged its lowest-ever quarterly average in the third quarter.

“If there is a disappointment it may come from trading revenues,” said Randy Frederick, vice president of trading and derivatives for Charles Schwab in Austin, Texas.

Analysts estimate earnings for S&P 500 financial companies fell 9.1 percent compared with a year ago, the weakest forecast among S&P 500 sectors, according to Thomson Reuters data.

“I think the sector is set up for disappointment,” said Feygin.

Reporting by Saqib Iqbal Ahmed; Additional reporting by Caroline Valetkevitch; Editing by Daniel Bases and Meredith Mazzilli

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