The sector in the cross hairs of the bond sell-off looks poised for a bounce, says Mike Khouw

An interesting tug of war is happening in one of the market's hottest sectors: utilities.

On hand, you have the historic AI buildout fueling an unprecedented earning boom in an otherwise stogy sector. On the other hand, you have fastest rise in Treasury yields since 1994 dimming the sector's otherwise bright shine and sending the sector lower. Leaders at major tech firms continue to emphasize massive energy needs, but any signs of rising interest rates or tighter credit conditions have hit capital-intensive utility stocks first.

Utilities' dividends are also attractive to income-focused investors, and rising rates presents competition for them as bond yields become more attractive relative to dividend paying stocks.

The Utilities Select Sector ETF (XLU) was already down sharply from its recent highs when the yield curve surged.

The problem with that selloff is that nothing has slowed long-term structural demand for power. As for the bond market, any sign the conflict in Iran may come to a end could push oil prices and yields lower. This morning's weaker than expected jobs report is already weighing on rates. Still, the key backdrop that has propelled utilities—unprecedented AI-driven power demand—remains fully intact, making this sharp pullback an attractive opportunity for a defined-risk bullish trade.

Given the sharp pullback to a historically average valuation, low implied volatility across the utility group, and the strong structural AI power thesis, we're looking at a bull call spread to bet on a rebound toward recent highs while keeping the net premium outlay low.

The Trade: Buy the XLU November 40/43 Call Vertical for an $0.85 net debit

Disclosures: Tidal owns/holds all the securities mentioned in the article.

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