EXC Option Activity A Good Sign For Utilities

EXC Unusual Option Activity Report

If you’ve been watching Treasury bonds lately, it’s been brutal and, as a result, utilities like Exelon Corporation (Nasdaq: EXC) haven’t done well. See, this type of rising interest rate market favors low-duration companies. However, as the 10-year U.S. Treasury bond yield approaches 1.5%, it may start to trigger rotation into high duration sectors like utilities. At least, that’s what the option activity on EXC is potentially indicating.

What is Duration?

One of the biggest indications of interest rate risk in the bond market is duration, but what about stocks like EXC and others? The concept of duration is also applicable to stocks in a similar fashion. In order to grasp the concept, let’s start with bonds.

For those that have traded options, you’re probably comfortable with the concept of delta. Delta measures the amount the option price will change with a $1 move in the stock. You may have not been aware that duration is a similar measure for bonds. It represents the amount the bond price will change with a 1% move in yield.

If inflation expectations are rising, typically lower duration and lower credit quality is preferred. In the event inflation expectations are falling, it would favor higher quality longer duration bonds. If you look at how Treasury bonds have performed to high yield credit, you’ll see that this rule of thumb has worked as commodity prices are exploding higher (an indication of inflation).

As you translate this to stocks, your lower beta names like EXC that pay a dividend would be similar to high-duration U.S. Treasuries. High beta technology and commodity names would be considered low duration. As a result, the impact of rising treasury yields, and falling high yield risk spreads has favored a riskier mix of assets.

In the chart below, you’ll see a ratio of Invesco S&P 500 High Beta ETF (NYSEARCA: SPHB) to the Invesco S&P 500 Low Volatility ETF (NYSEARCA: SPLV). As you’ll see by the rising line, the market has been favoring higher beta names over the past many weeks.

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