This week's decline in U.S. stocks has prompted institutional option traders to position for a more substantial pullback in exchange-traded funds covering the consumer, materials, banks and retail sectors.



After a positive start for the year, a sudden three-day reversal on Wall Street has raised the specter that a larger technical downside correction, perhaps of a magnitude of 20 percent, is looming in the first quarter.



Market participants noticed a burst of nearly 400,000 contracts traded in downside puts this morning in the Materials Select Sector SPDR fund, the SPDR S&P Retail fund, the SPDR KBW Regional Bank Index and the Consumer Discretionary Select Sector SPDR fund.



Investors — big and small — like ETFs because they are securities that track an index and can be easily bought, sold or shorted. Option investors often use them as an inexpensive way to protect portfolios or bet on sector movement.



Data shows the trades were buyer-initiated, opening positions by institutions and were struck about 20 percent out-of-the money, said Trade Alert President Henry Schwartz.



Schwartz said that each put was priced at a premium of below 25 cents per contract, making total premium outlay just $6.2 million, but the total value of stock holdings that the trades may have hedged was nearly $1.2 billion.



The puts had strike prices far below the current value of the underlying shares of the funds, suggesting a bearish picture for these ETFs in the next few months.



"There is some incredibly bearish action in the sector ETFs today," said Joe Kunkle, a founder of website OptionsHawk.com. "Although these far out-of-money puts may be against large long equity or futures positions, it is still reason for concern."



The high volume activity in these ETF options tracking these sectors had a common thread as the transactions were initiated in the March contract.



"The pattern appears to show large blocks of heavy protective put buying aimed at a 20 percent decline in those benchmarks by March expiration," said Andrew Wilkinson, market analyst at Interactive Brokers Group. "But what was not clear is whether this was protective or speculative action."



ETFs are also a good investment tool for diversifying a stock portfolio and to generate income.



According to Kunkle, the following trades were transacted:



In the Retail ETF, an investor bought 115,000 March $28 puts at a premium of 12.50 cents per contract, offer side, The XRT shares rose 8 cents to $35.34.



The Regional Banks ETF attracted a buyer of 60,000 March $20 puts at 22 cents per contract, near offer. KRE shares slipped 39 cents to $24.64.



The Consumer Discretionary ETF had a buyer of 140,000 March $24 puts at a premium of 12 cents. The XLY was off 3 cents to $29.56.



And in the Basic Materials ETF there was a buyer of 78,000 March $26 puts for 22 cents, and closer to the offer. The XLB edged up 4 cents to $32.30.



"These trades look to be betting on a 20 percent correction in the market by March," Kunkle said.

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