By Saqib Iqbal Ahmed
NEW YORK (Reuters) - Consumer staples stocks have served investors well through the last 12 months of market turmoil, but with quarterly earnings around the corner, activity in the options market spells caution.
With the exception of the smaller telecom and utilities sectors, consumer staples is the best performing S&P 500 (SPX) sector in 2016, up 5.5 percent for the year to date.
S&P 500 consumer staples are expected to report a first-quarter earnings decline of 2 percent, compared with a 7.6 percent drop for the broad index, according to Thomson Reuters data.
Procter & Gamble Co (N:PG), Philip Morris International Inc (N:PM) and Coca-Cola Co (N:KO) are among the big sector constituents set to report results in coming weeks.
But traders in the options market are not at ease. Bearish sentiment in Consumer Staples Select Sector SPDR Fund's options Exchange Traded Fund (ETF) (P:XLP) is close to the highest it has been in a year. For every open call contract, there are 5.2 puts open, according to options analytics firm Trade Alert.
Puts, usually used to bet on a decline in the fund's shares, make up 10 of the biggest blocks of open interest. Most of the open contracts are set to expire April through June, which means investors have an eye on the quarterly earnings season.
Another options measure, skew - the difference in cost between downside puts and upside calls expiring 90 days from now - is also the highest it has been over the last year.
Analysts peg this to how overweight investors are on the consumer staples sector. Credit Suisse (SIX:CSGN) data shows long-short hedge funds have been increasing their exposure to defensive shares in the last month relative to cyclical names.
"People are overweight defensives in general, and within that there is probably a very big overweight in utilities and staples," said Neil Azous, founder of Stamford, Connecticut-based advisory firm Rareview Macro.
The consumer staples and the Utilities Select Sector SPDR ETF (P:XLU) have attracted about $2.9 bln of net inflow this year, according to ETF.com data.
With U.S. stock market back to positive on the year and the U.S. Federal Reserve on hold, investors may be worried about the risk of a greater rotation into cyclicals going forward, said Azous, who has a short position in XLP shares.
Analysts also pointed to the lofty valuation for the consumer staples sector as a risk.
"The sector is trading more than 20 times both trailing and forward earnings," said Mike O'Rourke, chief market strategist at Jones Trading.
"It makes sense for investors to buy protection going into earnings season."