This post was written by OptionMonster.com analyst Chris McKhann.
Financial stocks have taken a beating in 2008 with one index down almost 60 percent, and one option trader is betting on more pain in the first quarter.
The XLF Financial SPDR came into 2008 near $30 and dropped to a low of $8.67 last month before rallying. The exchange traded fund sits at $12.31 in afternoon trading, up nearly 1.5 percent on the day.
The biggest options trade of the day was a put spread on the XLF, according to OptionMonster's tracking systems. One trader bought 20,000 of the February 12 puts and sold an equal number of the Febuary 10 puts for a net debit of $0.64 on the $2 spread. Selling the 10 put reduces the cost and exposure to time premium.
- More Options Tips from Jon Najarian
The spread caps potential upside if the XLF falls below $10, but it need only drop to $11.36 at expiration to produce gains. And if it does go below $10, it will still be roughly a 200 percent gain on the trade. If the trader had just purchased the 12 put, the XLF would need to drop below $10.93 for profit at expiration and below $9 to produce a similar percentage gain.
The implied volatility of the XLF is 66 percent, well off the high of 130 set on the low of Nov. 21. The 30-day historical volatility is much higher, at 108 percent. The 10-day historical volatility is more in line at 67.
The spread is a way to limit the cost of what is still historically high implied volatility while looking for the real volatility to keep up (to the downside, in this case).
Major Financial ETFs:
Vanguard Financials ETF
WisdomTree International Financial Sector Fund
iShares S&P Global Financials Sector Index Fund
iShares Dow Jones U.S. Financial Sector Index Fund
Jon 'DRJ' Najarian is a professional investor, CNBC contributor, and cofounder of OptionMonster.com.