Trade Update July 25th, 2012 at 11:10 am: MSFT has sold off about 5% since I put this trade on ahead of earnings. My only regret is that I did not add to the trade on the open of July 20th, after the earnings number had been released and the stock was trading up 1%. I only did this trade for 25% of my usual size. Regardless, I’ll take the winner here, as MSFT is near the lows of the last 4 months (near 28.75), and I’d rather focus on other opportunities, even though I think MSFT is likely to continue lower.
Action: MSFT ($29.00) Sold to close the Aug 30 puts at $1.39, for a $0.69 gain
New Trade July 19th, 2012 at 3:07 pm:
Windows used to be THE platform for computing. In every office and home around the world, Windows-based PCs were dominant. Not anymore. AAPL products have encroached on the consumer business, and now GOOG apps are encroaching on the enterprise business. Articles abound this week (like this one from CNET) detailing the efforts of MSFT to stop GOOG from poaching its enterprise customers.
With MSFT up 8% this week into earnings, I got curious about the bull case here. The stock has a relatively cheap valuation (11 P/E) and a decent dividend (2.5% yield). There is 15% earnings growth priced in for next year as analysts bake in expectations for the Windows 8 Upgrade Cycle. And the stock is up 20% on the year, so the bulls have done something right betting on Softie so far.
But therein lies the bear case too. The stock is up 20% in a year when it feels like competition for MSFT’s core business (not to mention its unsuccessful forays elsewhere) is increasing by the month. The 1 year chart shows how the optimism at the start of the year has gradually worn off, and this week’s rally offers a decent entry for a bearish bet:
The consensus earnings estimate for this quarter actually looks a bit low (second lowest in the past 8 quarters likely due to analysts expectations for corporations and consumers to push out pc purchase in front of the Windows8 release), and MSFT has rallied after earnings for 4 straight quarters, so I’m less certain about the earnings being a negative catalyst. Also, if IBM’s results were any indication of the potential for the strong dollar to hurt overseas sales, investors will be equally aware of this fact for MSFT as last year they got about 45% of their sales overseas (IBM saw a negative $1b currency effect on about $25billion in sales in Q2, MSFT is expected to have about $18b in sales in the quarter just ended).
But I like the overall setup, and implied vol is relatively cheap (implied vol in line with realized vol, which is rare before earnings). In line with my bearish macro view, I think MSFT is due for some weakness below $30 over the next month. HOWEVER, since I am not as confident about the earnings-related move, I am going to initiate a small, 25% of normal size position before the number, and if we get a rally tomorrow, I will likely up the size. The reason why I am initiating a small trade prior to earnings is because if earnings miss, I don’t think I will get another entry on the short side in MSFT.
MY TRADE: With the stock’s recent low (last week actually) at 28.54 as a potential target, I want to buy the Aug 30 puts outright with the thought of spreading them over the next few weeks on any weakness. The Aug 28 puts are only trading around 0.15, which doesn’t offer enough premium given how quickly MSFT is trading up and down 2 dollars these days.
TRADE: MSFT ($30.65) Bought the Aug 30 Puts for 0.60
- Bought 1 Aug 30 Put for .60
Break-Even On August Expiration:
Profits below 29.40, losses between 29.40 and 30.00, max loss of 0.60 above 30
CONVICTION LEVEL: I view MSFT as a good vehicle to express my overall bearish view. However, we are trying to do our best to avoid binary situations, especially around earnings, and especially when conviction level is not high, so the cheap implied vol gives us an opportunity to enter a small initial position.