European stocks were lower at midday Wednesday as mounting concerns over Italy's debt kept investors on edge, following an early rally sparked by Silvio Berlusconi's pledge to step down as Italy's prime minister.

Global lender HSBC (HSBA.L) featured among the biggest losers, sinking 5.3 percent after posting a drop in underlying profit, hurt by lower investment banking income and a surge in bad debt in the United States.

The FTSEurofirst 300 <.FTEU3> index of top European shares was down 1.7 percent at 966.78 points at 1049 GMT, having wiped out Tuesday's 0.9 percent gain.

Italy's benchmark FTSE MIB index <.FTMIB> tumbled 4 percent, with Mediobanca (MDBI.MI) down 5.9 percent and UniCredit (CRDI.MI) down 5.8 percent.

There is no guarantee (Berlusconi's) successor will be able to do a better job. Just keep your eyes on the Italian yield for now, Christian Jimenez, fund manager and president of Diamant Bleu Gestion, said.

As long as the 10-year bond yield remains above 5 percent, there is no green light to buy European stocks.

Berlusconi said after European markets closed on Tuesday he would quit as soon as the Italian parliament passed budget reforms urged by European partners to help Italy stave off a debt crisis threatening the euro zone. Votes on the reforms are likely this month in both houses of parliament and opposition leaders may try to bring this forward.

But his pledge failed to stop Italian bond yields from rising, with yields on 10-year benchmark Italian government bonds piercing through the key 7 percent level on Wednesday, which many analysts deem unsustainable for the country.

My read of it ... is that (ECB) official money is being held back from buying the Italian bond market in order to put pressure on the Italian political system to deliver on the structural reforms that they want, Andrew Bell, chief executive at Witan Investment Trust, said.

But I think there is a danger that the politicians or the ECB don't understand or can't quantify the risk of creating a tipping point in market confidence, he said.

And at that point, banks may start to withdraw lending or depositors start to taking money out of the garlic belt countries and put it in Germany or whatever, and they don't immediately reverse that next week if the ECB starts buying bonds. I think they are playing Russian roulette with market confidence.

ALTERNATIVE STRATEGIES

The FTSEurofirst 300 is up about 14 percent since tumbling to a two-month low in late September, but the recovery rally has been stalled by mounting worries over the finances of Greece and Italy.

While there isn't a clear trend in this market, we've started to play option straddles to at least benefit from the volatility, Diamant Bleu Gestion's Jimenez said.

A straddle is an options strategy with which an investor holds a position in both a call and put with the same strike price and expiration date.

The strategy is used to capture the volatility, regardless of the market's direction, by investors who think the underlying stock or index will move sharply, but are unsure about the direction.

Societe Generale's Cross Asset Research team suggests another market-neutral trading strategy to play in the current choppy market, a pairs trade of long Spanish stocks and short Italian stocks.

We recommend a basket of equities and corporate bonds to participate in the diverging political outlook in Spain and Italy, they wrote in a note. The pairs

Spain's IBEX <.IBEX> is down 16 percent so far this year, while the Italian FTSE MIB <.FTMIB> index has lost 26 percent over the same period.

(Additional reporting by Dominic Lau in London; Editing by Hans-Juergen Peters)

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