A way to play the too-hot utilities trade now that rate cuts have begun

Investors looking to participate in a new growth phase for electricity demand by purchasing the Utilities Select Sector SPDR ETF (XLU) might be discouraged by its massive run over the past year. We’ll review a way to play it with options that adds a buffer of protection. Overall electricity demand in the country is entering a new phase of growth. Only 6.9% of the current vehicle fleet in the U.S. is electric. While a 50% target by 2030 may be ambitious, EVs will likely outnumber internal combustion engine vehicles in less than a decade. Due to AI, farm and construction equipment will also likely become electric, and data centers are entering a new growth phase. And so since the October 2, 2023 lows, the XLU total return has been greater than 43% (exceeding the S & P 500 total return by more than 10.5%). XLU .SPX mountain 2023-10-23 Utilities Select Sector SPDR Fund since October low Despite this strong performance, the utilities select sector index still trades at just over 19 times forward earnings, a much cheaper multiple than the S & P’s 23.5 times, and typically trades with significantly lower volatility as well. Of course, the Fed’s half-point rate cut signals a more aggressive policy response, which benefits XLU in two ways. Spurring the economy will likely increase demand, but lowering rates improves the relative attractiveness of utilities for fixed-income investors as well. The trade XLU has an annual dividend yield of 2.8% and would make a fine addition to one’s portfolio. But suppose an investor would prefer a slightly higher yield and believes the recent outperformance and high Relative Strength Index reading may cause XLU to pause before resuming higher. In that case, a longer-dated call option , financed partly with the sale of a nearer-dated strangle, provides both upside exposure and a higher standstill yield than the dividend alone if one simply held the ETF. Sell Oct. 25 $75 XLU put Buy Jan. 17 $78 XLU call Sell Oct. 25 $81 XLU call DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.