I think we all agree the financials staged an impressive rally last week. Mind you, any rally lasting longer than four hours is considered impressive.

Less impressive was the pretext underpinning the rally. A morale boosting e-mail to Citigroup employees from Citigroups’ Chairman, suggesting the company was profitable in the first two months of 2009?

Digging ever so slightly between the cyber lines of e-mail, Citigroup acknowledged that it was talking about profits prior to expenses. There was very little discussion as to the impact “expenses” might have on the bottom line.

The reality of course, is that the credit crisis is far from over. LIBOR is again on the rise, indicating a growing degree of risk in interbank lending. The ability of the US government to service its debt was very publicly brought into question by China’s Premier Wen Jiabao. Emerging Eastern Europe is sinking into insolvency and an impending currency crisis. Making highly exposed Western European banks vulnerable to further defaults.

So, was last week nothing more than a momentum-driven rally supported by an oversold condition? As opposed to the beginning of a long lasting sustainable rally supported by a genuine change in sentiment.

If you agree with the momentum crowd, you might look at buying April at-the-money puts on Canadian financials. For example, with Royal Bank (TSX: RY) at $35.44, look at the RY April 36 puts at $2.40. Similarly, there is Toronto Dominion (TSX: TD) April 42 puts at $2.20, Bank of Nova Scotia (TSX: BNS) April 30 puts at $2.00.

On the other hand, if you believe that last weeks rally – because it lasted more than a few hours - was a watershed event, then you should probably expect a sharp move to follow. The larger question is whether that move will be up or down.

If you iare n this camp, you might consider trading volatility, rather than direction. And on that front we have seen some relief. While it is all relative, there is no denying that the cost of an option has been declining. At an average implied volatility of 40%, premiums are much higher than longer term trends, but well below last November highs. And more importantly, premiums seem reasonable given the trading pattern of Canadian banks since the beginning of the year.

For example, CIBC (TSX: CM) closed last week at $41.18. The options on CM are trading with an implied volatility of 40% well below CMs’ actual 30 day volatility of 66%. Putting some flesh on this skeleton, the CM April 42 straddle is trading around $5.50 (April 42 call @ $2.75 + April 42 put @ $2.75 = $5.50 straddle). That translates into an implied trading range over the next five weeks of $36.50 ($42 strike less $5.50 premium = $36.50) to $47.50 ($42 strike + $5.50 premium = $47.50).

If you are unclear about direction, but think that CM will likely breach either end of that trading range prior to the April expiration, then the CM April 42 straddle is the strategy of choice.