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This sector's incredible run is over: Technician

It's been a huge year for utilities stocks. Typically regarded as the most stable and boring part of the equity market, the S&P 500 utilities sector has risen 20 percent this year, making it 2014's best-performing sector save health care. But the charts indicate that the utilities rally will soon end, says Sterne Agee's chief market technician, Carter Worth.

This is a reversal for Worth, who accurately predicted back in May that utilities would stay strong for the next few months. And indeed, utilities stocks are up 7 percent since that time.

So why is he changing lanes now?

Worth's fresh bearish case starts with the chart of U.S. Treasury yields. Since utilities stocks are generally held for their generous dividend yields, lower Treasury yields are good for utilities stocks, as falling yields coax marginal investors to pick high-yielding stocks over bonds. A big driver of the utilities rally this year, then, has been the surprising drop in bond yields.

However, Worth thinks that yields are unlikely to fall from current levels, removing a potential driver for utilities stocks.

After the recent plunge in yields, "we've ricocheted back to basically a range where I think we're going to get stuck, and we're just going to stay range-bound for some time," Worth said Friday on CNBC's "Options Action." "So you don't have the tail wind, at this point, for utilities."

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It is when he moves on to the five-year chart of the ETF tracking the utilities sector (ticker symbol: XLU) that Worth finds a cause for concern.

"The point of trend lines is that I don't draw them, they draw themselves. This has been a perfect response—perfect!—over and over and over to the top and bottom of the channel," Worth said.

And right now, "we are at the top of the channel. And I say, I think you fade it here."

So how far will utilities stocks fall?

To answer that question Worth calls up a shorter-term chart of the ETF.


Referring to the recent range, Worth predicts that "we fall to the midpoint, which is around $42, and that would be about a 5 percent decline—which is fairly substantial for a slow-moving, low-beta thing like this."

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Michael Khouw of Dash Financial says the fundamentals support such a move.

"When you look at valuation in the utility space, a lot of these names are at, or well above, their long-term average multiples," Khouw said. And "to Carter's point, if anything, I could see rates go a little bit higher rather than lower."

So to play for such a move, and capitalize on the relatively low price of options, Khouw recommends buying the January 45-strike put on the SPDR Utilities ETF for $1.20.

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Since a put gives one the right to sell a given asset for a given price at a given time, this trade will make money if the XLU is below $43.80 (the strike price of $45 minus the options price of $1.20) at January expiration.

Disclosure: Neither Carter Worth nor Mike Khouw has a position on the SPDR Utilities ETF (XLU).

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