Why It’s Time to Buy Utilities
One of the sectors hardest hit since President Obama's reelection has been the utilities. The SPDR Select Sector Utilities ETF is down 4.8% versus a 0.60% decline in the S&P 500 since the election. Yesterday, one option trader made a bet that this sell-off was overdone, and that the XLU is due to rally into the end of the year. In the biggest trade of the day, this trader bought 36,766 December 35-strike calls for $0.23, while the stock was at $34.56. This is a bullish bet that will profit if XLU is above $35.23 (which would be 1.9% higher) at December expiration in 24 days.
The utilities sector has traditionally paid some of the highest and most consistent dividends in the market, and this explains its post-election slump. How's that? Well, investors fear that taxes on dividends will rise, sapping the utilities of some of their appeal.
However, at current prices, the utilities are starting to look like a bargain, which is what led this option trader to make a bullish bet.
By buying the December 35-strike XLU call option, this trader has locked in the ability to purchase the ETF at $35 at December expiration. At this level, the stock will yield 3.8%. Now historically, utilities have tended to offer a lower yield than investment-grade corporate debt, but the SPDR Barclays Intermediate Term Corporate Bond ETF is currently yielding just 3.2%. This could be a sign that XLU has been oversold, and is due for a pop. If the XLU were to tick higher until it yielded 3.2%, like the corporate bond ETF, then it would move all the way up to $41 (19% higher than yesterday's close).
Considering that the XLU offers a better yield than investment -grade corporate bonds – and also that, unlike bonds, the XLU maintains the opportunity for significant capital growth – the utilities ETF certainly seems to be a good bet here. Buying calls now is a low-risk, high-reward trade that locks in what is likely to be an advantageous entry point. For myself and for clients, I am looking to add this trade to our portfolio and come up smelling like roses. After all, I will be outlaying little cash, but giving myself the potential for a juicy reward.
Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."
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