Options Flare on Regional Bank Stocks

The options market is signaling that there may be trouble ahead for regional banks, according to one expert.

"We're looking for more volatile downside from the regional banks," said Rebecca Darst of Interactive Brokers on CNBC's "Squawk Box" Monday. "This is perhaps not going to come as any great revelation to people who have been following the financials for some time, but it's interesting nonetheless, because we're looking for continued erosion below the lows."

"A lot of these regional banks are reporting before the expiration of the July option series on July 18, but many of them are reporting afterwards, heading into the August contract, and yet what option traders are positioning for is continued erosion below the 52-week lows even before the expiration of the July contract. This seemed to get under way on Thursday, in any event, with Zions Bancorp , after an analyst suggested that Zions may face mortgage defaults in Arizona and Nevada."

Darst said the options action around Zion sent ripples through the whole sector. (See her full comments in the video).

"The sector as a whole is trading as something really quite toxic," Darst said. "We looked at action in KeyCorp , for example: Implied volatility there up 15 percent on Thursday, puts out-trading calls by eight to one, with fresh buying at the ten-dollar put strike in July and August; bear in mind that KeyCorp shares closed at 10 on Thursday, so that's looking for, obviously, some continued downside. Something option traders may want to keep an eye on, as we continue to see these rumblings in the regional banks, which are grappling not only with their exposure to bad mortgage loans, but also bad construction loans, is the bad scuttle around the regional banks sort of trickles up to the super-regional bank, in this case being Wachovia , so you're going to look for increased implied volatility."

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