Utility Playa (XLU) Update

by riskreversal October 31, 2016 3:05 pm • Trade Updates

Back in September we looked at the near term prospects for higher bond yields after U.S. Treasuries had just come off of historic lows and the likelihood that at least one rate increase by the FOMC in 2016 appeared like a lock. At the time, we thought it made sense to check back in on bond proxies in the equity market that had come off hard from recent highs.  Specifically we thought the XLU, the etf that tracked the Utility sector might be poised for a bounce back to prior highs as it was our view that there would not be more than one increase in 2016. From Sept 15th:

If the Fed does not raise at their Dec 14th meeting (after punting on Sept & Nov), utility stocks will likely be back near 52 week highs at $53.  And even if they do raise in Dec, we may have already seen the reaction in these stocks, and rates. The XLU appears to have fairly good technical support at $48, which also corresponds with its 200 day moving average (yellow line below), this is where I would want to define my risk to on the downside.

And we expressed that view this way:

*XLU ($49) Buy Dec 49 / 54 call spread for $1.50
  • Buy to open 1 Dec 49 call for 1.65
  • Sell to open 1 Dec 54 call at 15 cents

Well, it was a wild ride since then. We were initially right as the XLU popped back up to 51, but then it saw fierce selling straight through that 48 support before bottoming around 47. It is now back above its 50 and 200 day moving averages on a 2.2% move higher today:

screen-shot-2016-10-31-at-12-27-26-pm

With XLU at 49.50 the trade is basically unchanged from our entry at $49. As far as trade management the pop above the moving averages today is significant and that level should be used as a stop on the downside ($49). If XLU is able to consolidate at or above that level and build then the trade is set up nicely into December. There’s very little chance of a rate hike in the upcoming FOMC meeting Wednesday (especially after the FBI tape bomb on Friday) as the Fed will have no interest making headlines right before the election. So that leaves December’s meeting as the “live” one and it makes sense to watch Fed Fund futures markets for any shifts in sentiment.