Trade Update MSFT: Turning Oct Puts into Put Spread

by Dan October 18, 2012 3:23 pm • Commentary

Trade Update Oct 18th, 2012: DAN:  

Action: MSFT (29.40) sold the Oct 28 put at 0.09, now long Oct 29 / 28 put spread for 0.13

Break-Even on tomorrow’s close 28.87 or lower

Idea here was to try to leg into a near the money put spread using the broad tech weakness, at this point I am risking .13 to make .87 if the stock is down 5% tomorrow, which given the results and reactions by INTC, IBM and GOOG in the last few days this is not a massive stretch.

Here is the thing, there is a lot of bearishness in PC supply chain and maybe the quarter they will report reflects that, but the guidance could reflect optimism about Windows 8 release.  SO i am taking a low risk, low premium defined risk bet.



New Trade Oct 18th, 2012: DAN: On Friday I took off a winning Oct Put Spread when the stock was ~$29, I am now getting back in……

New Trade: MSFT (29.55) bought the Oct 29 Puts that expire tomorrow for .22.

Break-Even on tomorrow’s close 28.78 or 2.6% lower …….given GOOG’s price action, the 29 puts look cheap in vol and $ terms.



Original Post Oct 18th, 2012:  MSFT Q3 Earnings Preview

Event: MSFT reports earnings today, Oct. 18th, after the close.  The stock is implying a 2.75%, almost in line with the 4 quarter averaged of 3.25% and 8 quarter average of 3%.  MSFT has rallied on 4 of the last 5 earnings releases.

Sentiment: Wall Street analysts are relatively bullish, with 29 buys, 12 holds, and 1 sell.  Short interest is quite low, at 1.35% of float according to Bloomberg, but it has almost doubled in the past 6 months.

Fundamentals: Microsoft has a pristine balance sheet, as its $60 billion of cash is enough to cover all of its liabilities, and then some.  Its main issue has been earnings growth, since there has been none in the past year.  Analysts and investors expect that the Windows 8 will deliver earnings growth of 20% over the next year.  That will be the crux of the trading story in the months to come.

So instead of analyzing financial metrics that everyone can see, the real question is, will Windows 8 succeed?  Will its related product cycle (tablets and PCs) be enthusiastically adopted by consumers?  Can it gain any traction in mobile?  

Reviews so far have been mixed.  I’ve seen quite a few tech blogs claiming that Windows 8 will be the downfall of Microsoft.  The platform is just too confusing, too complicated.  But they’re has been a vocal minority who says that Windows 8 software provides the necessary platform and flexibility to serve all the various product types.  These advocates say, once consumers get over the learning hurdle, the Windows 8 upgrade will be powerful.  Will they make the effort to get over the hurdle?

Valuation:  The P/E multiple is near 5 year (and all-time) lows, as the stock has lost its growth mojo, but offers an attractive 3% dividend.  Of course, as we saw with INTC, that 3% dividend yield can become 4% quite quickly if investors start to see the overall business as declining.  Here is the 5 year chart:



Once again, I don’t view current valuation as a good argument for bulls or bears.  Windows 8 will show whether Softee can grow again, or if those days are over.

Price Action:  This 3 year chart is one of the most boring I’ve come across in the entire market:



I didn’t even draw any annotations because the range has been so tight (approximately 24 to 32).  I would note that MSFT is still up almost 15% year-to-date in 2012, close to in-line with SPX and Nasdaq.

Volatility:  The chart of 90 day implied volatility over the last 2 years shows how traders are unwilling to buy options on MSFT.  Given that the stock has been stuck between 28 and 32 for most of the year, that’s no surprise.  Chart:


from LiveVol Pro


Options are cheap because the stock has not moved.  But I do think we are close to a period where option buying in MSFT will make sense, as speculation around Windows 8 heats up.

My View: Today’s earnings is likely to be a non-event, and I see very little of interest in the options market.  However, we are approaching the Windows 8 release, and its success or failure should cause a rather large move higher or lower over the next year for MSFT.  I anticipate some good trading opportunities around that event.