Utility Sector Begins to Heat Up!

Dear Reader,

Yesterday, we looked at a Monthly Price Chart of Main Street Capital Corp., noting that MAIN’s 1-Month Price is trading above the 10-Month SMA signaling a ‘Buy’.

For today’s Trade of the Day e-letter we will be looking at a Moving Average Convergence/ Divergence (MACD) chart for the SPDR Utilities Select Sector ETF, symbol: XLU.

Before breaking down XLU’s MACD chart let’s first review the investment objective of the ETF.

The Utilities Select Sector SPDR Fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Utilities Select Sector Index.

MACD Indicator confirms Price Momentum

The XLU daily price chart below shows that XLU is in a price uptrend as the 24/52 day MACD line (black line) is above the 18-Day EMA (purple line). The Moving Average Convergence/ Divergence chart is shown below the daily price chart.

MACD uses moving averages to create a momentum indicator by subtracting the longer-term moving average from the shorter-term moving average. The MACD is calculated by subtracting an ETF’s longer term 52-Day Exponential Moving Average (EMA) from its shorter term 24-Day EMA. This creates the MACD line.

MACD ‘Buy’ Signal

The 18-Day EMA line functions as a buy/sell ‘trigger’. When the 24/52 Day MACD line crosses above the 18-Day EMA line it indicates positive momentum and higher prices for the ETF. When the 24/52 Day MACD lines crosses below the 18-Day EMA it indicates negative momentum and lower prices for the ETF. MACD is more of a leading indicator than a moving average crossover which tends to lag price movement.

MACD Histogram shows Acceleration of Momentum

Also included in a MACD chart is the histogram bar graph. This portion of the chart helps to illustrate the distance between the 24/52 Day MACD and the 18-Day EMA.

When a crossover initially occurs, the histogram’s bar will be near flat as the two indicator lines have converged. As the lines begin to separate, the bars grow in height, indicating a widening gap and acceleration for the ETF’s momentum. When the histogram’s bars begin to shrink this indicates a narrowing of the gap between the 24/52 Day MACD and the 18-Day EMA and a slowing of the ETF’s momentum. When the gap between the two indicators begins to narrow, this typically indicates a crossover of the indicator lines could happen soon.

Buy the XLU ETF

As long as the 24/52 Day MACD line remains above the 18-Day EMA, the ETF is more likely to keep trading at new highs in the coming days and weeks.

Since XLU’s bullish run is likely to continue, the ETF should be purchased.

Our initial price target for XLU is 70.80 per share.

93.7% Profit Potential for XLU Option

Now, since XLU’s 24/52 Day MACD is trading above the 18-Day EMA this means the ETF’s bullish rally will likely continue. Let’s use the Hughes Optioneering calculator to look at the potential returns for an XLU call option purchase.

The Call Option Calculator will calculate the profit/loss potential for a call option trade based on the price change of the underlying stock/ETF at option expiration in this example from a flat XLU price to a 12.5% increase.

The Optioneering Team uses the 1% Rule to select an option strike price with a higher percentage of winning trades. In the following XLU option example, we used the 1% Rule to select the XLU option strike price but out of fairness to our paid option service subscribers we don’t list the strike price used in the profit/loss calculation.

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Trade with Higher Accuracy

When you use the 1% Rule to select an XLU in-the-money option strike price, XLU only has to increase 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money call option and the underlying ETF closes flat at option expiration it will result in a 100% loss for your option trade! In this example, if XLU is flat at 68.76 at option expiration, it will only result in a 7.7% loss for the XLU option compared to a 100% loss for an at-the-money or out-of-the-money call option.

Using the 1% Rule to select an option strike price can result in a higher percentage of winning trades compared to at-the-money or out-of-the-money call options. This higher accuracy can give you the discipline needed to become a successful option trader and can help avoid 100% losses when trading options.

The goal of this example is to demonstrate the powerful profit potential available from trading options compared to ETFs.

The prices and returns represented below were calculated based on the current ETF and option pricing for XLU on 5/6/2024 before commissions.

When you purchase a call option, there is no limit on the profit potential of the call if the underlying ETF continues to move up in price.

For this specific call option, the calculator analysis below reveals if XLU increases 5.0% at option expiration to 72.20 (circled), the call option would make 43.0% before commission.

If XLU increases 10.0% at option expiration to 75.64 (circled), the call option would make 93.7% before commission and outperform the ETF return more than 9 to 1*.

The leverage provided by call options allows you to maximize potential returns on bullish ETFs.

The Hughes Optioneering Team is here to help you identify profit opportunities just like this one.

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Wishing You the Best in Investing Success,