Earlier this week, the Federal Reserve once again opted against raising interest rates, dealing disappointment to investors that had piled into financial services exchange traded funds over the past several weeks in anticipation of the Fed’s first interest rate hike of 2016.
The Financial Select Sector SPDR (NYSEArca: XLF) and rival financial services ETFs started this year off as laggards but shed that laggard status as many market participants began pointing to June and July as ideal times for the Fed to boost rates. Obviously, that did not happen this month and that is encouraging some traders to turn bearish on XLF or hedge long positions in the ETF.
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With a steepening yield curve, or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long.
Financial entities like banks will benefit from expanding margins as rates climb. A rising rate environment may reflect a strengthening U.S. economy, and a healthier economy would help borrowers have an easier time repaying loans, with banks stuck with fewer non-performing assets. Moreover, rising rates means that banks will generate greater revenue from the spread between what they pay deposit savers and the prime rates they charge credit-worthy clients and other highly-rated debt.
Thursday brought an explosion in put options activity in XLF, the largest financial services ETF.
“The 21-day moving average of XLF put volume over call volume is just off its highest point in more than two years, peaking at 2.85 last week. As a result of this growing accumulation of puts, the exchange-traded fund’s (ETF) put/call open interest ratio is at its highest point since January,” according to Schaeffer’s Investment Research. “Honing in on near-term options, puts more than double calls among options expiring within three months, as measured by the ETF’s Schaeffer’s put/call open interest ratio (SOIR) of 2.30. This ratio stands higher than 93% of all others from the past year, reflecting the bigger-than-usual put-bias among near-term traders. Further, the 50-day moving average of the SOIR is now at its highest point since March 2015.”