Behind the million-dollar bets on the banks

Breaking down a big bet on the financials

After a great week for the financials, it looks like some traders are betting millions that the best is still ahead for the sector and for the exchange-traded fund (XLF) that tracks it.

On Friday morning, one trader appeared to buy 39,000 August 25-strike call options on the XLF for 44 cents per share. Since each call options contract gives its purchaser the right to buy 100 shares of the underlying stock or ETF for an agreed-up price on a certain date, this represents a $1.7 million bet that the XLF will be even higher come the middle of August.

This isn't the first big bet seen on the financials. On Thursday, one of the biggest ETF trades was the purchase of about 22,000 25.50-strike call options on the XLF expiring in July, for 16 cents per share.

It's not known whether these two trades were executed by the same party, or indeed, whether they represent a small part of a larger strategy. But on its face, this appears to show that big money continues to see upside for the group largely composed of bank stocks.

"These traders clearly are making a nice bet that the financial rally will continue," Jacob Weinig, co-founder of options-focused hedge fund Malachite Capital, said Friday on CNBC's "Trading Nation. "

And since they're using relatively short-term options, they are not paying much to do it. The Friday trade may have cost nearly $2 million, but it garnered exposure to $96 million worth of the ETF. If the XLF manages to rise 10 percent over the next seven weeks, the trade will return $6.6 million.

On the other hand, if the XLF closes below $25 on Aug. 18, the options will be worthless, and the amount paid will be lost. The trade breaks even at $25.44, which is the striking price plus options premium paid.

The financial sector logged a 3.25 percent rise last week, for the group's second-best week this year. The bank stocks got some welcome news, as each bank passed the Federal Reserve's stress test, and the Fed consequently approved banks' capital return plans.

In Weinig's view, the buyers of these options are likely betting that the financials will see further gains following their second-quarter earnings announcements, most of which are coming in mid-July.

Between potentially positive earnings, an improving regulatory environment thanks to the Trump administration, and an increase in dividends and buybacks, Weinig sees good reason for traders to bet on the banks right now.