* Appetite for call options on Italian banks rises
* 24 of 28 euro zone banks still trade below book value
* First LTRO sparked a two-month 25 percent rally in banks
By Blaise Robinson and Sudip Kar-Gupta
PARIS/LONDON, Nov 20 (Reuters) - Investors are buying eurozone bank stocks and options in anticipation of a fresh round oflong-term loans from the European Central Bank, with Italianlenders seen benefiting most from any new cash.
European banks are still scarred from the regional sovereigndebt crisis and a new health check on lenders next year may showyet more capital shortfalls, but traders said they were stillhoping for a recovery in the sector.
The ECB injected over a trillion euros ($1.3 trillion) intomarkets through two long-term refinancing operations (LTROs) inDecember 2011 and February 2012 to prevent a credit crunch. Thismonth's unexpected interest rate cut fuelled speculation that athird liquidity boost could be on the cards.
This would fuel a rally in bank stocks although the impactmight not be as spectacular as the 25 percent jump in the twomonths following the first, surprise LTRO.
"A new LTRO would not spark euphoria on the markets, itwould rather further reassure investors about the measures takento support the sector in its recovery," said Dylan Baron, fundmanager at Quilvest Gestion, which owns shares in Italy's IntesaSanpaolo and Spain's Banco Santander.
"Because these banking stocks are recovering from such lowlevels, any additional measures from the ECB could fuel gains inthe shares, which would outperform."
Compared to late 2011, concern over financial companies hasabated but weak third quarter earnings from Italian banks showeda full recovery may be some way off so another liquidity boostcould enable the banks to lend more.
"The Italian banks are the ones which would benefit the mostfrom it, given the fact that they haven't yet fully paid backthe money from the previous LTROs and are having difficultiesfinding liquidity," said Arnaud Scarpaci, fund manager atMontaigne Capital, who does not have equity positions in Italianbanks but is looking into buying shares.
"This would bring much-needed breathing space here."
BCM & Partners' Roberto Giacalone also said Italian bankswould be among the main beneficiaries of another LTRO.
According to Reuters data, euro zone banks still have to payback about two-thirds of the funds from the two LTROs, roughly600 billion euros, with Italian banks still holding 230 billioneuros in LTRO money.
A fresh cash injection would reduce the strain on theirbalance sheets and show the ECB's determination to support thesector.
Despite a sharp rally since mid-2012 that has seen the STOXXeuro zone bank index almost double in price, 24 of theindex's 28 banks still trade below their book value, a keymetric for bank stocks as it measures the value of their assets.Italian shares are among the cheapest stocks.
Banco Popolare trades at 0.3 times book value,while UniCredit trades at 0.5 times and Intesa trades at 0.6times - compared with an average price-to-book of 1 for Europeanbanks, and of 1.8 for European stocks overall - as investorsremain concerned about possible writedowns with Intesa issuing awarning this month over its dividend.
After the ECB rate cut, euro zone banking stocks rose asmuch as 3.8 percent, before running out of steam. The sector isstill up about 40 percent since late June, more than double therise of the broad STOXX Europe 600 index.
Given uncertainty about the timing, size and duration of anynew liquidity injection from the ECB, many investors favour call options instead of buying the shares directly. A call givesthe right, but not the obligation, to buy a stock at apre-determined price at a later date, with the losses limited tothe premium if the stock price falls below the strike price.
Appetite for calls on a number of euro zone banks has beenrising, with the open interest on March 2014 calls for Intesamore than doubling since late October, according to Eurex data.
"Calls are quite cheap at the moment, and if things gowrong, you don't lose much," Montaigne's Scarpaci said.
Barclays derivatives strategists suggest buying callsimplying possible expectations of a 14 percent rise in Intesa'sshares over the next two months.
Others prefer options on the STOXX euro zone bank index,which are cheaper and more liquid than single stocks bets.
Phoebus Theologites, chief investment officer at SteppenWolfCapital, recommends buying a December 2014 call on the bankingindex with a strike price 6 basis points, or 4.25 percent,higher then the current level of the index.
"In 13 months' time, given that another LTRO will take placesooner or later, you can be pretty sure that the index will haverisen by more than 4.25 percent from current levels, so net-netyou will make money if you believe in the LTRO and thecommitment of the ECB to help the euro zone banks survive."