New Trade $MSFT: On the Surface, Softie Still Looks Screwed

by Dan March 21, 2013 11:09 am • Commentary

ORCL’s weak results and outlook confirm some of the reasons for the YTD relative under-performance of the Nasdaq, regardless of how much weight you want to place on AAPL’s contribution.  With ORCL down a little more than 9% this morning, it strikes me that some large cap tech implied vol in Apr looks cheap.

Foremost among those is MSFT.  The company is slated to report earnings on Apr 18th, after the close, and it will be a closely watched report for visibility on Windows 8 demand, particularly guidance for enterprise demand in the second half of 2013.  It’s common knowledge that Win8 has been a failure among the consumer crowd, but there is still hope among the investor base that enterprise uptake of the new software helps second half 2013 / full year 2014 numbers.  Also investors and analysts will be keeping a close eye on Surface sales and guidance for the new product as many analysts are also viewing their foray into tablets as an early bust.

From a vol perspective, here is the 1 year comparison of 30 day implied vol (red) vs. 30 day realized vol (blue):

[caption id="attachment_23925" align="alignnone" width="636"]MSFT 30 day IV vs. 30 day RV, Courtesy of Bloomberg MSFT 30 day IV vs. 30 day RV, Courtesy of LiveVolPro[/caption]

Implied vol is very cheap, but realized vol is also at the lows of the year.  However, earnings is now less than a month away, so April options are not likely to decay much between now and the event, given how cheaply they’re priced.  For example, the Apr 28 straddle priced at 1.15 is about a 4% move in either direction, when MSFT has moved 2.6% on earnings over the past 4 quarters.  In other words, Apr options will likely only lose 35% of their value between now and earnings, in the case that stock is totally unchanged.  That’s cheap optionality for the next 3 weeks.

Directionally, we haven’t liked the stock for a while.  But the technicals are finally lining up for a decent entry on the short side.  The 3 year chart with the 200 day ma in black:

[caption id="attachment_23926" align="alignnone" width="633"]MSFT 3 year chart, Courtesy of Bloomberg MSFT 3 year chart, Courtesy of Bloomberg[/caption]

MSFT had a long-term trend change in the middle of last year, as the 200 day moving average moved from upward sloping to downward sloping.  After Window 8 head Sinofsky left in November, the stock broke down on a massive gap.  Since then, the stock has fought its way higher to finally close that gap (marked by the red line).  But the downward sloping 200 day moving average as well as all of the overhead supply from trading in 2012 makes this a great entry for a trade playing for a retracement of recent gains.

Here’s the trade:

Trade: MSFT ($28.16) Bought the Apr 28 Put for .50
  • Bought 1 Apr 28 put for .50

Break evens on April Expiration:
-Losses of up to .50 between 27.50 and 28, max loss of .50 above 28

-Profits below 27.50

Trade Rationale:  Given ORCL’s indication that enterprise spending might be weak, MSFT’s last hope for some green shoots in its business looks more precarious than ever.  Add to that the cheap level of April options ahead of a pivotal earnings event, and this trade is a cheap way to play for some Softie disappointment.  On any broad market weakness I will look to spread by selling a lower strike put prior to earnings.