“Financial stocks may face more volatility in coming weeks as a sweeping overhaul of the U.S. financial industry looks set to pass in early July. Options strategists say there are several strategies investors can use to play the pending financial regulation ranging from the conservative to the speculative,” Doris Frankel Reports From Reuters.

“There has been concern that the pending congressional reconciliation bill would have further downward pressure on the financial sector before the fourth of July holiday weekend,” said Scott Fullman, director of derivative investment strategy at broker-dealer WJB Capital Group in New York.

Frankel goes on to say, “The sector has fallen more than the broader market in the last several weeks. The S&P Financial Index is down about 15.8 percent since April 14, more than the S&P 500, which is down 10.7 percent in that time. The legislation is being shaped into final form by a U.S. Senate-House panel, and with the final language in the bill not determined, it leaves open the possibility of surprises for investors.”

“To speculate or protect against a sharp decline, Fullman recommended a 1-by-2 ratio put spread in the Select Sector SPDR Financial fund. The ETF, which tracks the performance of the financial names from the S&P 500, ended at $14.74 on Thursday. This involves buying one XLF July $15 put option and selling two XLF July $12 put options, resulting in a total net cost of 59 cents. The upper break-even point is $14.41, the lower break-even is $9.59. Below $9.59, the strategy loses money, he said. An equity call option allows share purchases at a fixed price up to a certain date. A put option grants the right to sell the shares at a preset price anytime until expiration, ” Reuters Reports.

Brian Overby, senior options analyst at online brokerage TradeKing in Charlotte, N.C., said put option prices in the banks have already become “quite pricey.” “One way to lower the cost of protection is to employ a collar strategy, a trade that can give some downside protection while waiting for the outcome of financial reform legislation,” Overby said.

Victor Schiller, president of InvestorsObserver.com, an equity options research and analysis firm in Charlottesville, Virginia, said current bank stock prices already reflect expectations for lower profits from the anticipated bill. “The worst case scenario of this bill is probably baked into the most widely-held bank issues such as Goldman Sachs (NYSE:GS), Citigroup Inc (NYSE:C), Bank of America Corp (NYSE:BAC), and Wells Fargo & Co (NYSE:WFC),” Schiller said.

But there are wild cards in the legislation. Key reforms still under consideration would require reporting of over-the-counter derivatives trades to regulators. The Senate measure goes a major step further in requiring banks to spin off their swap-trading units.

As a result of whether financial reform is baked into sector, today the Financial Select Sector SPDR ETF (NYSE:XLF) was off 4% at the closing bell Friday as stocks plunged on Europe’s escalating debt crisis and a soft May jobs report. Citigroup Inc. (NYSE:C) shares lost 4% wile Bank of America Corp. (NYSE:BAC) declined nearly 3%.

Here are some more details we put together on the Select Sector SPDR Financial ETF (NYSE:XLF) below:

The investment seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of publicly traded equity securities of companies in the Financial Select Sector Index. The fund will normally invest at least 95% of its total assets in common stocks that comprise the relevant Select Sector Index. This fund has adopted a policy that requires it to provide shareholders with at least 60 days notice prior to any significant material change in its policy or its underlying index. It is nondiversified.

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