Financial worries spark bearish option trades in ETFs

CHICAGO, April 22 (Reuters) - Many options traders on Wednesday appeared to be taking a protective stance and employed bearish strategies in several exchange-traded funds on concerns the stock market's recent gains are overdone.

The bearish activity comes on a day of choppy trade in the stock market. The Dow Jones industrial average .DJI and the Standard & Poor's 500 index .SPX finished the session lower after disappointing results at Morgan Stanley reignited worries about the banking sector.

The market has been sensitive to the outlook for banks before the release of the federal government's "stress test," expected as early as Friday.

Option trading was heavy in the Direxion 3X Financial Bear Fund (FAZ.P), or FAZ, a leveraged exchange-traded fund designed to move inversely to the financial sector. Its shares hit a low of $8.58, but bounced back as financials lagged late in the session. It closed at $9.90, up 7.73 percent.

The ETF's option volume rose to double the normal levels, with 92,000 calls and 17,000 puts traded, according to option analytics firm Trade Alert.

"Some investors bought May calls at the $9, $10, $11, $12.50, $14, and $15 strikes -- betting that financials might falter and FAZ will move higher," said Frederic Ruffy, options strategist at Web information site WhatsTrading.com.

When bank stocks and other financials fall, the ETF will move higher.

"It is designed to move three times as fast as the Russell 1000 financial services index, so the fund is extremely volatile," Ruffy said.

REFLECTION OF BANK AND RETAIL WORRIES

Options in the Financial Select Sector SPDR ETF (XLF.P) or XLF were also active with 334,000 puts traded versus 120,000 calls, Trade Alert data showed. XLF shares fell 3.21 percent to close at $10.25.

"The overall activity reflects concerns about the problems in the financial world and some sectors of the economy, like retailers and consumer discretionary names," Ruffy said.

Andrew Wilkinson, senior market analyst at Connecticut-based Interactive Brokers Group, said one investor played a cautious ratio put spread in the XLF September contract. The trade involved the purchase of 10,000 September $11 strike puts for a premium of $2.10 spread against the sale of twice as many puts at the September $7 strike price for 48 cents a piece.

"This trade suggests precious little upside for financial stocks between now and the end of the summer," he said.

The trader stands to gain $2.86 per contract compared to the initial $1.14 net cost, should XLF shares fall 31 percent to the $7 strike by September expiration, Wilkinson said.

Meanwhile, the Consumer Discretionary Select Sector SPDR Fund (XLY.P), which holds retailers and other consumer stocks, attracted a large trade of downside put options. It appeared that a large block of close to 50,000 lots in the June $19 put strike was bought by a single investor, Wilkinson said.

The trade exceeds established positions in that strike, indicating a new position. XLY shares would need to fall 14.5 percent over the next two months for the trade to reach the strike price, he said. XLY shares rose 1 percent to $22.24.

"This investor senses that there is still more discomfort for consumers going forward," Wilkinson said. (Editing by Jan Paschal)