I have talked about the bullish prospects for the Utility sector on a number of occasions over the last 6 months in posts on Seeking Alpha. One of the primary reasons I have been very bullish is just how cheap utility stocks were from a fundamental perspective. However, even now one is still able to pick up utility stocks for P/Es less than 10 and with dividend yields in the range of 5%. So at the very worst I do not think there is much in the way of downside in utility counters.
One of my concerns some 6 months ago was the lack of convincing market action in the Utility sector. It seemed that utility stocks were locked in a never ending trading range, or at least the major indices were. However, now they have broken to the upside and are trading at multi-week highs on both an absolute and relative performance basis - relative to the S&P 500 (NYSEARCA:SPY).
But the fundamental valuations and technical performance is probably no secret to many investors. However, what most are unaware of is just how cheap options are for utility stocks. Implied volatility on options trading on the Utilities Select Sector SPDR ETF (NYSEARCA:XLU) is more or less as low as it ever has been in the last 6 years.
Below is the graph of implied volatility of 12month ATM options on XLU. I apologize in advance for the quality of the graph but this is about as good as Bloomberg graphs get:
In investing it is not about being right or wrong, rather it's how much you stand to lose if you are wrong vs. how much you could potentially make if you are right. A small investment into LEAPS on the ETF XLU or large cap utility stocks in general may well bring a very Merry Christmas in 2012!
Disclosure: I am long XLU. Long OTM LEAPS on XLU