* 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 euro zone bank stocks and options in anticipation of a fresh round of long-term loans from the European Central Bank, with Italian lenders seen benefiting most from any new cash.
European banks are still scarred from the regional sovereign debt crisis and a new health check on lenders next year may show yet more capital shortfalls, but traders said they were still hoping for a recovery in the sector.
The ECB injected over a trillion euros ($1.3 trillion) into markets through two long-term refinancing operations (LTROs) in December 2011 and February 2012 to prevent a credit crunch. This month's unexpected interest rate cut fuelled speculation that a third liquidity boost could be on the cards.
This would fuel a rally in bank stocks although the impact might not be as spectacular as the 25 percent jump in the two months following the first, surprise LTRO.
"A new LTRO would not spark euphoria on the markets, it would rather further reassure investors about the measures taken to support the sector in its recovery," said Dylan Baron, fund manager at Quilvest Gestion, which owns shares in Italy's Intesa Sanpaolo and Spain's Banco Santander.
"Because these banking stocks are recovering from such low levels, any additional measures from the ECB could fuel gains in the shares, which would outperform."
Compared to late 2011, concern over financial companies has abated but weak third quarter earnings from Italian banks showed a full recovery may be some way off so another liquidity boost could enable the banks to lend more.
"The Italian banks are the ones which would benefit the most from it, given the fact that they haven't yet fully paid back the money from the previous LTROs and are having difficulties finding liquidity," said Arnaud Scarpaci, fund manager at Montaigne Capital, who does not have equity positions in Italian banks but is looking into buying shares.
"This would bring much-needed breathing space here."
BCM & Partners' Roberto Giacalone also said Italian banks would be among the main beneficiaries of another LTRO.
According to Reuters data, euro zone banks still have to pay back about two-thirds of the funds from the two LTROs, roughly 600 billion euros, with Italian banks still holding 230 billion euros in LTRO money.
A fresh cash injection would reduce the strain on their balance sheets and show the ECB's determination to support the sector.
Despite a sharp rally since mid-2012 that has seen the STOXX euro zone bank index almost double in price, 24 of the index's 28 banks still trade below their book value, a key metric 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 0.6 times - compared with an average price-to-book of 1 for European banks, and of 1.8 for European stocks overall - as investors remain concerned about possible writedowns with Intesa issuing a warning this month over its dividend.
After the ECB rate cut, euro zone banking stocks rose as much as 3.8 percent, before running out of steam. The sector is still up about 40 percent since late June, more than double the rise of the broad STOXX Europe 600 index.
Given uncertainty about the timing, size and duration of any new liquidity injection from the ECB, many investors favour call options instead of buying the shares directly. A call gives the right, but not the obligation, to buy a stock at a pre-determined price at a later date, with the losses limited to the premium if the stock price falls below the strike price.
Appetite for calls on a number of euro zone banks has been rising, with the open interest on March 2014 calls for Intesa more than doubling since late October, according to Eurex data.
"Calls are quite cheap at the moment, and if things go wrong, you don't lose much," Montaigne's Scarpaci said.
Barclays derivatives strategists suggest buying calls implying possible expectations of a 14 percent rise in Intesa's shares 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 SteppenWolf Capital, recommends buying a December 2014 call on the banking index 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 place sooner or later, you can be pretty sure that the index will have risen by more than 4.25 percent from current levels, so net-net you will make money if you believe in the LTRO and the commitment of the ECB to help the euro zone banks survive."