Option Volume Up in KRE Regional Bank ETF

Imagine there are two companies. Company A is a huge multinational corporation with offices all over the world, making money in several different products along one industry. Company B is smaller, less multinational, and more a regional firm. What Company B lacks in business lines and scope it makes up for in efficiency, customer service and satisfaction. Which company would you want to invest in?  Here’s some more — Company A is a large bank and that its practices include dealing in large blocks of European debt; and that Company B is a regional bank that survived and actually swallowed several weaker banks coming out of the melt down. Which would you prefer investing in now? This might be why the KBW Regional Banking ETF (NYSE: KRE ) has been outperforming other banking ETFs like the Financial Select Sector SPDR (NYSE: XLF ). It's not that XLF has done poorly, as it is up about 10% since the end-of-November lows. But the KRE has done profoundly better, rising about 20% since the beginning of December.  This type of movement has caused a massive spike in option volume over the last few days, with the KRE December 22 Calls reaching more than 140,000 contracts. That's on an ETF with an average open interest of about 100,000. (And that number would have been much lower if we measured it two weeks ago). Even more intriguing than the volume was the one directional nature of the trades. Traders spent the entire day buying collars (long downside put, short upside call), buying calls out right and selling puts. The biggest trade was what appears to be a huge bullish call buy on the KRE March 30 Calls tied to a small delta. The trader sold a block of stock, most likely reducing an existing long position, and then spent some of the profits buying the 30 calls for 0.25. I believe the trader was protecting some profits, but wanted to make 'bank' if the banking index continued to rise. I like the purchase for several reasons:  The index is sitting on really low implied volatility (IV) levels relative to the last two years. While this could drop even lower as this index heads toward normalcy, that drop in IV would almost certainly have to mean a rally in the underlying. This would make call buying the better play than put selling. There appears to be more industry consolidation ahead, while we do not know the affects of the Dodd-Frank bill, or the final effects of the melt down, as banks get stronger, and the big boys are forced to spin off some of their trading arms. It might make sense for a Bank of America (NYSE: BAC ) to scoop up a bank.  There are many international banks that are also interested in the regionals as a way to get their foot into the U.S. door. As the economy begins to heat up the U.S. consistently out paces the EU in growth, so if I was an international bank with a lot of capital, I would be trying to expand into the U.S. One example was the rampant rumor that Banco Santander (NYSE: STD ) was trying to buy M&T Bank Corp . (NYSE: MTB ) last summer. While certainly a different type of product, Toronto-Dominion Bank (NYSE: TD ) bought Chrysler Financial Corp. just this week. If I was going to trade KRE I would be looking to buy some upside calls. However, the 30 Calls do not seem as practical to the average investor. I would be looking to buy the March 27 or 28 Calls as they have a lower implied volatility than some of the extreme upside, while still being somewhat 'dollar cheap.' Follow Mark Sebastian on Twitter @option911 .
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