Bank derivatives boom ahead of ECB test results as investors play safe

Tue Sep 30, 2014 4:51am EDT
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By Francesco Canepa

LONDON (Reuters) - Investors hopeful but not entirely confident that next month's European bank check will yield positive results are stacking up derivatives positions to balance optimism about the industry against worry over its performance in a faltering economy.

The European Central Bank is expected to publish the outcome of its bank asset quality review on Oct. 26 in a bid to convince investors - after three previous "stress tests" failed to spot subsequent problems - that Europe's lenders have sifted out their risky holdings and now have enough capital to withstand any more financial crisis-style shocks.

However recent nasty surprises are still vivid. The euro zone banking index fell nearly 17 percent between April and August as poor economic data from Italy, France and even Germany threw into doubt a euro zone recovery while top banks like BNP (BNPP.PA: Quote), Lloyds (LLOY.L: Quote) and Royal Bank of Scotland (RBS.L: Quote) were hit with hefty fines for misconduct ranging from sanctions violations to manipulation of key interest rates. Portugal's announcement of a 4.9 billion-euro ($6.22 billion) bailout for Banco Espirito Santo BES.LS caused more pain.

With all that in mind, investors are hedging their bets.

As a way of taking a punt without putting much capital at risk, many are turning to call options - which offer the right but no obligation to buy shares at a certain price and time.

Derivatives strategists at JPMorgan, Societe Generale and BNP Paribas have all been advising their clients to bet on a modest rally after the results' publication.

"Investors ... cannot afford to miss a potential strong rally that could be triggered by this event, but do not always have sufficient conviction to just buy cash equities," said Davide Silvestrini, head of European equity derivatives strategy at JP Morgan.

Since the summer, interest in banking sector call options has surged: There are currently more open bets on a 9 percent rise on the Euro STOXX banking index by December than there are on a roughly equivalent fall, Thomson Reuters data showed. This is an unusual occurrence because investors tend to hedge against a fall rather than a rise in shares.   Continued...

The headquarters of the European Central Bank (ECB) is pictured prior to the bank's monthly news conference in Frankfurt July 3, 2014. REUTERS/Ralph Orlowski