The Utilities Select Sector SPDR Fund (AMEX:XLU) seeks to provide investment results that correspond to the price and yield performance of the Utilities Select Sector of the S&P 500 Index. The XLU includes companies from industries such as electric utilities, multi-utilities, independent power producers and energy traders, and gas utilities.
While the S&P 500 has struggled this year, utilities have been a star performer, with the XLU showing a gain of nearly 10% year-to-date, and making a new annual high at $34.75.
XLU’s huge relative outperformance shows how defensive investors have become in seeking out safety and yield. However, at some point, this dramatic relative outperformance will wane and revert to the mean. I feel we are approaching this level.
On a sentiment basis, the 9-day Relative Strength Index (RSI) is showing an overbought level at 72, which has been concomitant with intermediate-term tops in the past. The last five times the 9-day RSI has exceeded 70 have been extremely reliable in marking tops in XLU over the past two years.
On a fundamental basis, XLU is now trading at a premium to the S&P 500 on a price-to-earnings (P/E) metric, sporting a nearly 14-multiple compared to 12 for the S&P 500. This comparative valuation premium has also been a reliable indicator of short-term overbought levels in XLU. I’m looking for that valuation divergence to revert back to a more normal, slightly inverted structure over the coming months, with XLU being a relative underperformer.
Given my flattish outlook for the S&P 500, I think the XLU will drop toward the $32 level by the end of January.
Based on the XLU’s current market price of $34.88 and using a target price of $32, a target date of Jan. 31, 2012, and $1,000 of investment capital, it’s an excellent candidate for a bearish option play, should the price target be achieved at the target date.
To play this with options, visit TradingBlock.com, create a free Instant Login and try the TradeBuilder feature. Input the ticker, target price and date, and investment amount, and you’ll see several ways to trade that include buying a March put or a put spread, selling a March call spread, or using some more-advanced strategies.
Best of all, you can see a potential profit-and-loss outline for each strategy. If you set up an account, you can hit the “Trade” button on your preferred strategy and be on your way! Create your free login, and get access to these XLU option trading strategies by visiting the TradeBuilder here.
