Use utilities to power up your portfolio

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Michael Fowlkes 12/16/2013

Investors are no different than anyone else… we all like new and flashy things. As a result, companies with high-profile, cutting-edge products are typically the ones that catch the most media attention. As a result, they are also the ones that investors often consider first when looking to for new places to invest their money.

Whenever I find myself discussing the stock market with friends or family, the same names always seem to be the center of the discussion. Perhaps it's Tesla ( TSLA ) and electric cars, or Facebook ( FB ) and Twitter ( TWTR ) for their massive social networks. Lately the conversation tends to center around wearable computing devices that are on the horizon from Apple ( AAPL ) or Google ( GOOG ). This is what people know, and these are the stocks that they are interested in purchasing.

While it is true that these types of stocks are exciting, and the upside can sometimes be tremendous, they are also the exact same stocks that tend to be volatile and can run into unexpected selling pressure when things start to go wrong. You can look at Tesla as an example. The stock started the year around $35, worked its way up to high of $194.50 in September, and has since fallen back to $147.47. These stocks are exciting, but with that excitement comes additional risk.

Rarely, if ever, do any of my friends want to talk about Dominion Resources ( D ) or Sempra Energy (SRE). Why would they? These are the most boring stocks you can imagine. What they have in common is that they are both utility stocks. Dominion is an electric utility company and Sempra is a natural gas company. Neither is very exciting to talk about.

Another thing that these two companies have in common is that both have been ( quietly ) producing solid gains for a long time.

Dominion Resources is up 27% year-to-date. Sempra Energy has not risen quite as much as Dominion, but 2013 has still been a solid year. It's gained 25% year to date.

There are two things that I really like about utility stocks. For one, they tend to have low volatility, so while you may not see a utility stock shoot up 30% in a month, you rarely hear about them dropping that much either. Sexy stocks can easily produce these gains or losses in a quick time period, but prudent investors know the value of stability, and utility stocks provide that level of comfort.

A second aspect to utility stocks that like is that most are solid dividend payers. As such, investors are able to build their portfolio's income while at the same time holding stocks that are stable and likely to move higher with the broader market.

One final thing that both Dominion and Sempra have in common is that they are both held in Utilities Select Sector SPDR (XLU). This is a utility-based exchange-traded fund.

While I am bullish on utilities in general, it is important to keep in mind that a lot of utility stocks are interest-rate sensitive. Because of the high dividends that are often associated with utility stocks, investors buy into these stocks when interest rates are low in search of yield and it looks like we are entering a period where interest rates are going to move higher.

The Federal Reserve has not announced a concrete time for when it plans to taper its monetary easing, but that day is coming. It is expected to start sometime towards the beginning of 2014, and when that does happen, rates will begin to rise. This could result in selling pressure in utility stocks, so it would be wise to consider a cautioned approach to the sector with a hedged play on Utilities Select Sector SPDR (XLU). I like trading XLU because it is diversified over enough stocks to prevent any major downside moves from a single negative event, and using a hedged trade will allow us to realize a nice return even if XLU does start to move lower.


Chart courtesy of stockcharts.com

One hedged trade on XLU to consider is the March 33/35 bull put credit spread. To set up this trade, you would sell the March 35 put while buying the same number of March 33 puts for a credit of 26 cents. The trade has a target return of 14.9%, which is 54.5% on an annualized basis (for comparison purposes only). XLU is currently trading at $37.57, so the trade has 6.1% downside protection.




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com


This article appears in: Investing , Options

Referenced Stocks: AAPL , D , FB , GOOG , TSLA

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