What’s next for those beaten-up financial stocks? That’s the most hotly debated issue on Wall Street and, over the last two weeks, my single biggest reader question.

The interest is understandable. The world’s biggest banks have been stung by nearly $50 billion in write-downs, the latest yesterday’s $2.7 billion mortgage writeoff by Barclay’s, and ongoing credit woes suggesting that more are on the way in the $20 trillion worldwide asset-backed securities market.

Late last week, the financial sector — which represents nearly 20% of the S&P 500 weighting and is down 13.8% this year — began to show signs of firming. That led some market pros to begin bargain hunting.

“Too soon. It’s unlikely to last,” investment adviser Bill Rhodes of Boston-based Rhodes Analytics tells me. “The financials are on my list of weak sectors and should stay there for a while because there’s probably more downside to come.”

Ditto Gary Wollin, a San Francisco money manager whose firm, Gary Wollin Company, manages nearly $100 million of wealthy individuals’ assets. “I don’t think the last shoe has dropped in collateralized debt obligations or subprime mortgages, which has to mean more pressure on financial stocks,” he says.

Penny Rubin is a concerned financial stockholder. “Help,” she e-mailed me. “We’re getting killed. My husband and I bought Citigroup in the mid-$50s and it’s now in the mid-$30s.” (Actually, it’s $34.14.) “We’re out almost $38,000. Our broker says we should sell and use the money to buy another financial stock, OptionsXpress Holdings, which we never heard of. What would you do?”

As far as Citigroup goes, Standard & Poor’s shares that negative view of the banking giant. It has chopped both its 2007 and 2008 earnings estimates and has cut its price target on the stock 23%, to $45, from $59, which represents a discount to its historical valuations.

S&P worries about the bank’s weaker financial structure, with Citigroup’s capital ratios having fallen below its targets as a result of acquisitions and the migration of leveraged loans and commercial paper to its balance sheet. While S&P thinks it’s unlikely that Citigroup, stung by big losses in subprime mortgages and possibly facing lawsuits because of it, will cut its dividend, it nonetheless feels the suspension of share buybacks and possible asset sales may be necessary to boost capital levels. This, in turn, could preclude Citigroup from taking advantage of market opportunities over the near term.

S&P is hardly alone in its concern about Citigroup. The latest figures show a hefty short interest — a bet a stock price will fall — of 29.1 million shares despite a sizable decline from their 52-week high of $57. Said one Citigroup short seller: “With all the turmoil there is in the credit markets these days, who knows what other problems may be lurking at the bank? The answer is no one can be sure. I think you could easily see Citigroup’s stock in the mid-$20s in three to six months.”

OptionsXpress is an online broker that has carved out a strong position in the growing market of options and futures trading, and posted revenues last year of $188.4 million. Thanks to the broker’s sizzling earnings growth, it has caught the eye of an outperforming investment newsletter out of Hammond, Ind. Upside, that is no stranger to this column because of its impressive track record in picking winning stocks.

Upside is gung-ho on OptionsXpress, whose earnings in recent years ran $0.29 a share in 2003, $0.55 in 2004, $0.79 in 2005, and $1.15 in 2006. Further, consensus Street estimates call for additional growth to $1.49 a share this year and to $1.72 next year.

In its most recent quarter, the company posted a 54% earnings gain on a 46% revenue increase. The quarter also turned into a significant growth period for the company on several other fronts. Noteworthy was the addition of 12,500 new accounts, putting the total at 247,800, and a 32% increase in total client assets at the end of the quarter, to $5.62 billion. In the same period, OptionsXpress’s daily average trades rose 53%, to 36,900.

The company, fueled by favorable trading trends and continued customer growth, seems quite capable of beating Wall Street expectations, which it has done in eight of the last nine quarters, the editor of Upside, Richard Moroney, says. Moreover, he sees potential niche acquisitions, improved cost controls, and margin gains bolstering results.

Mr. Moroney rates the stock a “best buy,” the newsletter’s highest designation, but hastens to caution that it’s likely to be volatile and highly sensitive to market movements. Based on its strong operating momentum and attractive valuation (about 17 times estimated 2008 earnings), he figures the stock ops could reach a high of $36 over the next 12 months, about a 24% gain from its current price of $27.64.

A word of caution: Betting on David to beat Goliath is always fraught with risk.

dandordan@aol.com