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(Corrects option strategies in par 16 to 'call spreads', not'put spreads')
* Investors consider bank stocks as ECB sifts test results
* Hope that risky lending is mended, but economy a worry
* Options a way to access any rally with limited capital
* Strategists tip bet on small rise after results out
By Francesco Canepa
LONDON, Sept 29 (Reuters) - Investors hopeful but notentirely confident that next month's European bank check willyield positive results are stacking up derivatives positions tobalance optimism about the industry against worry over itsperformance in a faltering economy.
The European Central Bank is expected to publish the outcomeof its bank asset quality review on Oct. 26 in a bid to convinceinvestors - after three previous "stress tests" failed to spotsubsequent problems - that Europe's lenders have sifted outtheir risky holdings and now have enough capital to withstandany more financial crisis-style shocks.
However recent nasty surprises are still vivid. The eurozone banking index fell nearly 17 percent between April andAugust as poor economic data from Italy, France and even Germanythrew into doubt a euro zone recovery while top banks like BNP, Lloyds and Royal Bank of Scotland were hit with hefty fines for misconduct ranging from sanctionsviolations to manipulation of key interest rates. Portugal'sannouncement of a 4.9 billion-euro ($6.22 billion) bailout forBanco Espirito Santo caused more pain.
With all that in mind, investors are hedging their bets.
As a way of taking a punt without putting much capital atrisk, many are turning to call options - which offer the rightbut no obligation to buy shares at a certain price and time.
Derivatives strategists at JPMorgan, Societe Generale andBNP Paribas have all been advising their clients to bet on amodest rally after the results' publication.
"Investors ... cannot afford to miss a potential strongrally that could be triggered by this event, but do not alwayshave sufficient conviction to just buy cash equities," saidDavide Silvestrini, head of European equity derivatives strategyat JP Morgan.
Since the summer, interest in banking sector call optionshas surged: There are currently more open bets on a 9 percentrise on the Euro STOXX banking index by December thanthere are on a roughly equivalent fall, Thomson Reuters datashowed. This is an unusual occurrence because investors tend tohedge against a fall rather than a rise in shares.
That reluctance to commit money to bank shares is reflectedin the current performance of the Euro STOXX banking equityindex - currently 10 percent off its March peak.
But, say some investors, that dip also means the potentialfor fresh gains if the ECB publishes a positive report.
STAMP OF APPROVAL?
Those expecting a surge in banking stocks are basing theirposition on the fact that the ECB's asset quality review (AQR)is likely to confirm that banks have got themselves into shape.
Sources familiar with ECB thinking told Reuters recentlythat the central bank is likely to say most banks have improvedsince the crisis abated last year.
That would remove a threat currently hanging over the banks- that of more capital increases, which dilute equity and sendshareholders running, pummelling share prices - and insteadallow banks to focus again on lending, helping to improve theeconomy and their own profits.
"Post-AQR you'll have a sort of stamp of approval comingfrom the ECB on the banks' capital levels," said Gerry Fowler,global head of equity and derivatives strategy at BNP Paribas.
"Even with the fairly consensus view that the stress testswon't be bad, you could still see the Euro STOXX banking indexup 5 percent just because the deluge of data increasestransparency."
Derivatives strategists have been advising clients to takeout 'call spreads' which typically involve buying a call to beexercised at a price equal to or slightly above current levels,while also selling another call with a higher price, both to cutthe cost of the trade and limit potential losses if shares fall.
BNP Paribas recommended buying one December call with strikeprices of 155 or 160 points, effectively betting on a rally ofat least 6-9 percent, and selling two calls with strikes at 165or 175 points, or 12 to 19 percent above current levels.
Some warier investors were looking at longer-dated options.
Vincent Cassot, head of equity derivatives strategy atSociete Generale, tipped buying a call with a 150 points strikeprice, 2 percent above the current level, due to expire in March2015, financed by selling a call with a 170 points strike.
"If you have the sector going up quickly, then you're goingto still do well, if not, you're going to have more time withthe March 15 expiry," Cassot said.(1 US dollar = 0.7875 euro) (Editing by Sophie Walker)
