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By Doris Frankel
(Reuters) - Option investors worried about Russia's exposure to the banking crisis in Cyprus have been stepping up their bearish bets in one of the largest exchange-traded funds focused on Russian stocks.
There has been a surge in bearish activity in options of the Market Vectors Russia fund on expectations that shares in that country could lose ground if Russian depositors are forced to pay taxes in Cyprus to help bail out the small island nation.
Russians have billions of euros at stake in Cyprus's crippled banking sector, which needs about 10 billion euros (8.53 billion pounds) in aid to stay afloat. In order to get aid, the European Union is demanding that bigger depositors - which include many Russians - take a hit.
Activity in bearish put options exceeded bullish call options by a ratio of nearly 43-to-1 late on Friday, according to options research firm Trade Alert, as put activity has surged and the ETF's price has dropped.
"A flood of put activity has been evident in the RSX, suggesting continued concerns for the safety of Russian deposits in Cyprus," said Gareth Feighery, a founder of options education firm www.MarketTamer.com in Philadelphia.
Shares of the RSX ETF are down more than 7 percent this year and the fund saw more than $65 million in outflows for the week ended March 20, the heaviest week of outflows since November, according to Lipper, a unit of Thomson Reuters.
Trading in the fund has increased sharply. On March 13, more than 9.5 million shares traded and on March 20 more than 13 million shares changed hands, compared with average daily volume of 3.75 million over the past 50 days.
Russia rebuffed Cypriot entreaties for aid on Friday, leaving the island's increasingly isolated leaders scrambling to strike a bailout deal with the European Union by next week or face the collapse of its financial system.
Russians are believed to account for most of the 19 billion euros of non-EU, non-bank money held in Cypriot banks when last counted in January.
Feighery said the unusual put activity began on March 15, when put volume on the January 2014 $25 strike spiked to 2,410 contracts, more than 20 times the highest volume of any other strike price. The January 2014 $25 strike puts is also home of the fund's biggest open interest with 10,891 contracts.
Traders exchanged 8,084 puts so far, more than double their recent daily average against 189 calls by Friday afternoon, according to Trade Alert, for a 42.77-to-1 ratio, far surpassing the average ratio of 2.31 over the past 22 days.
Most of the action is in the downside April $26 strike puts, which appear to be bought, strategists said.
The April $26 strike puts traded more than 7,000 times on Friday, with the volume purchased in two large blocks, 5,600 puts at a premium of 25 cents apiece and 1,400 puts at 20 cents apiece, perhaps as a hedge against further weakness in the ETF, said Interactive Brokers Group options analyst Caitlin Duffy.
The puts start to make money if RSX shares trade below the average break-even price of $25.76 by April expiration.
Those puts "would increase in value if Russia's equity market declines because the ETF holds shares of leading companies from that country," said WhatsTrading.com options strategist Frederic Ruffy.
The fund's top 25 holdings include oil and gas giant NK Lukoil OAO, pipeline company Gazprom OAO, and telecom holding company VimpelCom Ltd.
The noteworthy action in the April $26 puts suggests that concerns remain high that the recent drop in RSX shares will continue until the stalemate is resolved, Feighery said.
Investors often turn to equity puts, contracts granting them the right to sell a stock at a fixed price by a certain date, to speculate on potential stock weakness or to protect an existing stock position. An equity call conveys the right to buy a company's shares at a fixed price.
Option traders see more risk to the ETF's shares reflected by its projected volatility, which measures perceived risk of future stock movement. Implied volatility for the next 30 days for RSX options stood at 21.32 percent on Friday, a nearly 20 percent rise in six trading sessions, said Ophir Gottlieb, managing director of options analytics firm Livevol.
(Reporting by Doris Frankel in Chicago; Editing by Nick Zieminski)