Dan previewed MSFT’s earnings after the close. We were looking at potential options structures around the event. MSFT is up more than 30% in 2013, one of the best performers among the mega-cap stocks this year. The stock found resistance around 36.50 earlier this week, and has bounced off of the 50 day moving average on multiple occasions this year (now at 34.50). In that sense, our initial inclination was to structure a trade that targeted that range, though implied volatility was a bit too low to entice us on any trades that sold volatility for a range play.
However, we did get a question from someone interested in protecting a long position in MSFT. So this is how we’d play:
Theoretical Trade Against a Long – MSFT (35.55) Sell the Sept 37 call to buy Sept 35/33 put spread for 0.05
- sell 1 Sept 37 Call at 0.50
- buy 1 Sept 35 put at 1.00
- sell 1 Sept 33put at 0.40
Rationale – This structure gives up your long stock 37, which is close to the 10 year high in MSFT at 37.50. It offers protection between 34.95 and 33 between now and September. The low in MSFT stock at the market lows in June was 32.57, so you get to protect the bulk of the range between 35 and the recent low. The initial outlay is only 0.05 of premium in case MSFT closes between 35 and 37 on Sept expiry. Because MSFT vol isn’t that high the 37 strike was chosen to finance a tight put spread. If 37 is too tight to the upside and you’d want more upside, the best you could do for that is to roll the call up to 38 in Sept or even higher in a farther out month. The tradeoff is the put spread would be lower and so you wouldn’t have as tight protection to the downside. But if your gains are good in the name (you own it from much lower), that may be the better way to go.
Theoretical Trade For Someone Interested in Playing for a Breakout – MSFT (35.55) Buy the Aug 36 / Jul26th 36.50 Call Diagonal for $0.38
- buy 1 Aug 36 Call for 0.59
- sell 1 Jul26th 36.50 Call at 0.21
Rationale – First off, it’s worth noting that we don’t view a breakout in MSFT as likely given the weak reports to date among its large cap tech peers (most notably, INTC last night). So we wouldn’t do this trade ourselves. But in the even that MSFT puts up a strong quarter and makes a new high, 37.50 is the level to watch on the upside. Since implied volatility is lower than normal ahead of earnings, this trade leaves you long volatility after the earnings event and has a sweet spot of 36.50, the high of the year. But if the stock eventually breaks out in August, the trade could be a nice winner.
$MSFT Fiscal Q4 Earnings Preview
11:05 am EDT – July 18, 2013
Event: MSFT reports their fiscal Q4 earnings tonight after the close. The options market is implying about a 3.3% move for the event, which is rich to the 4 qtr average of 2.25% and the 8 qtr avg of 2.65%.
Sentiment: Despite the stocks nearly $75 billion ytd gain in market capitalization, Wall Street analysts remain fairly mixed on the stock with 19 Buys, 21 holds and 2 Sells with an average 12 month price target of $36, almost exactly where the stock is trading now. Short interest sits at a measly 1% of the float.
Fundamentals: Same Old Same Old for MSFT, PC shipments are absolutely dismal, as market research firm Gartner stated last week (here):
Worldwide PC shipments dropped to 76 million units in the second quarter of 2013, a 10.9 percent decrease from the same period last year…This marks the fifth consecutive quarter of declining shipments, which is the longest duration of decline in the PC market’s history.
Top Ranked PC analyst Rick Sherlund from Nomura, who rates the shares a Hold with a 12 month price target of $38, in a note to clients Monday suggested that MSFT would likely report an inline quarter:
We look for revenues of $20.8bn, up 15% on a reported basis or up
7.6% normalized for the unusual deferred revenues relating to tech
guarantees from the launch of Windows 8 and Office 2013.
We expect EPS to be $0.76, up 11% from $0.68 last year, but
normalized for tech guarantees we estimate EPS of $0.68, down 8%
from $0.73 last year.
Windows revenues should be flat on a normalized basis on an estimated
10.9% decline in PC units for the quarter (Gartner estimate). Excluding
Windows revenues (which are most closely associated with PC units), we
estimate the reminder of the business likely grew revenues about 10%
overall. PC units probably reached their trough in calendar Q1 and we
estimate will decline at a slower rate over the second half on easier
comparisons and some benefit from Intel’s new Haswell
Guidance will likely be the key to whether or not the stock has any near-term continued upside, as the company will likely guide for the current quarter and for fiscal 2014.
Aside from financial results, Sherlund is very focused on the the recently announced management reorganization and the potential for activist investor ValueAct to seek a spot on the board.
As for Valuation? You know the drill. It trades below a market multiple of ~12x next year’s expected earnings that analyst suggest should grow about 10% with sales increasing ~8%. The company pays dividend that is currently in line with the yield on the 10 yr Treasury, and with about $60 billion in cash, net of debt on their balance sheet, or about 20% of their market cap, the company will be sure to announce a monster share re-purchase agreement when their existing $40 billion one runs out in Sept.
Price Action / Technicals: As I stated above, MSFT’s ytd gains of ~34% have tacked on nearly $75 billion in market, quite a number when you consider the reception by consumers and businesses of their major new products. The 7 year weekly chart shows the importance of the 36.50 to 37.50 area, which was the high from 2007:
7 year weekly chart of MSFT, Courtesy of Bloomberg
The 1 year chart of MSFT shows the strong breakout on high volume in April (volume in lower panel):
1 year chart of MSFT, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg
Since that breakout, the stock has found support at the 50 day moving average on a few instances. The 50 day ma is currently around $34.50. The high of the year is earlier this week at $36.43.
Vol Snapshot: Nothing too exciting in the options as far as volatility is concerned. August vol is about 21, last cycle it was more like 26. Following earnings it should fall into the mid to high teens.
from LiveVol Pro
MY VIEW: As a bit of a follow-up to what I wrote in the MorningWord (here), trying to figure out how MSFT will trade after tonight’s results will likely depend on getting a sense for what is “IN” the stock at current levels. If you are a MSFT investor and don’t already know that PC sales are weak, and likely to get weaker for eternity, and this will be a continued headwind for their Windows franchise then you shouldn’t be allowed to own stocks. If you don’t know that their Surface Tablet is and will continue to be a failure then shame on you for not picking your head up from playing Minecraft… on your iPad. If you missed NOK’s disappointing unit sales of Windows based phones announced just this morning then you should reconfigure your notifications on your iPhone5. SO, I think that a lot of the negatives on some of their high profile products are IN the stock, so to speak, at current levels.
SO, why does the stock continue to work, much like YHOO of late, largely because of the unknowns? The big one, and likely the largest single opportunity for the company, is continued progress with their move into the cloud with their Office 365 offering. This appears to be the focus of most bulls.
From a technical set up, the previous highs from 2007 should offer a bit of upside resistance, while a consolidation in the $34 to $36 range would likely be very healthy. We are not expecting an out-sized move like YHOO, remember it takes some fairly significant fundamental news to move a $300 billion market cap stock. We are going to look for some range trades that could make sense in the name.