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Trader bets big on a quick rally in financials

After selling off last week, the financial sector saw a slight bounce, and one trader is betting over $1 million that the financials will move even higher in the next three weeks.

On Monday, the financial sector ETF (trading under the ticker symbol XLF) was up 0.3 percent. However, call options on XLF outnumbered puts by a ratio of 6-to-1. A call is a bullish wager giving the purchaser the right to buy a stock within a given time, while puts are bearish wagers giving purchaser the right to sell.

The transaction that caught the eye of many traders was an enormous purchase of the 24.50-strike calls expiring on April 17. This trade was for 68,000 contracts at a price of 21 cents, meaning the buyer is expecting XLF to move above $24.71 or almost 1.8 percent above Monday's closing price of $24.28, by expiration. Since each contract controls 100 shares, the total amount paid for this trade was almost $1.43 million.

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According to Dan Nathan, co-founder of RiskReversal.com, the trade was apparently timed to take advantage of the upcoming earnings season. Data compiled by FactSet show that seven of the top 10 holdings in XLF are expected to report before the April 17 expiration. Those seven companies comprise more than a third of the ETF's assets.

XLF holding
% of assets
Earnings release date
Berkshire Hathaway 8.9% May 1
Wells Fargo 8.6% April 14
JPMorgan Chase 7.7% April 14
Bank of America 5.6% April 15
Citigroup 5.3% April 16
U.S. Bancorp 2.7% April 15
AIG 2.6% April 30
Goldman Sachs 2.6% April 16
American Express 2.4% April 15
Simon Property Group 2.0% April 24

Of the S&P 500's 10 sectors, financials are expected to show the most earnings growth this quarter, according to S&P Capital IQ. Earnings in the sector are projected to be 10.9 percent higher than in Q1 2014. Health care and consumer discretionary stocks are close behind, with expected growth of 9.0 and 7.4 percent, respectively, while half of all sectors are expected to show earnings declines.

Yet financials have been one of the worst performers this quarter. The sector is down 2.4 percent year to date, with only energy and utilities trailing.

Nathan suspects the trader who bought the 24.50-strike calls is targeting just a small move to the upside in XLF based on upcoming earnings. He sees $25 per share – around its December highs – to be the most likely target should XLF see a short-term pop. But such a move would mean the trader would see a profit over the next three weeks of $1.97 million, or 138 percent of the premium paid.

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