Regional bank exchange traded funds have been rallying the past few weeks to lead the financial sector and outperform large-cap banks.

Year to date through Jan. 11, SPDR S&P Regional Banking ETF (NYSEArca: KRE) was up 7.4%, more than doubling the 2.9% gain for the S&P 500, according to Morningstar. [Regional Bank ETFs Display Financial-Sector Strength]

Trading in options based on the regional bank ETF have skyrocketed recently as investors use the fund to play the breakout or hedge, according to Street One Financial. [ETF Chart of the Day: Regional Banks]

S&P Capital IQ recently boosted its outlook on U.S. regional banks to positive from neutral as the sector gears up for earnings season.

Bank ETFs ended 2011 in the red, although regionals performed much better than large-caps.

“Bank valuations were heavily weighed down in 2011 by a trifecta of bad news, including the Japanese tsunami and nuclear disaster, the U.S. economic slowdown with total federal gridlock and accompanying sovereign debt downgrade, and the seemingly never-ending European debt and banking crisis,” S&P analyst Erik Oja said in a note this week. “At times, it looked like 2008 all over again, but thankfully history didn’t repeat itself that quickly.”

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