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 (
) and electric cars, or Facebook (
) and Twitter (
) for their massive social networks. Lately the conversation
tends to center around wearable computing devices that are on the
horizon from Apple (
) or Google (
). 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 (
) 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 (
) 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
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.
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