MorningWord 8/26/13: $MSFT – A Window Into All That Sept Call Buying

MorningWord 8/26/13:  The primary goal of RiskReversal.com is to help educate readers as to the alternative ways to express (or augment) views in the equity markets using options, usually with a strong emphasis on capital preservation.  Whether you are drawn to the options market for their most popular uses among retail investors – yield enhancement, leverage or risk management, – it is very hard to ignore the headline grabbing nature of unusual activity.

As regular readers know, we often comment on unusual activity in our real time “Quick Hits” section on the main page of the site, while also Tweeting when we can confidently report an untied (not delta neutral) directional, opening or closing trade.  We are not in the camp that reporting large volume for the sake of it is that useful if it is traded vs a large block of stock as often times we will never know if the trade has any directional bias whatsoever.  We are also not believers that chasing unusual options activity is a profitable strategy because from our professional experience, unless you know the original trader’s intention with the trade, you will always remain at a massive disadvantage.  How can following an unknown trader blindly possibly qualify as a sound capital allocation decision?

Which leads me to Friday’s tape-bomb:  that MSFT CEO Steve Ballmer will be “retiring” within 12 months, which immediately sent the stock up 8%, towards $35, very near the highs since Ballmer took over from founder Bill Gates less than 1o years ago.  Back on Aug 7th and 8th we highlighted in Quick Hits and in our Too Many Options posts, what we confirmed to be untied, opening & directional call buying:

5:25 PM EDT – AUGUST 7, 2013 BY ENIS

MSFT – Stock was the best performer in the S&P top 50 today.  The Sept 33 calls traded over 80k, with a midday buyer of around 50k at 0.20, and the Sept 32 calls traded over 60k on the day an average price of $0.545

Again, to repeat, when we report such activity it is not a recommendation to jump on board, and we merely use the info as another input as we assess the underlying stock.  In this situation this information helped me NOT make a mistake.  With the market apparently losing some steam in early August, after the SPX made a new all time high on Aug 2nd, we were looking for stocks that had recently disappointed on June quarter earnings and we thought could be vulnerable in a broad market decline with the added kicker of weak company specific fundamentals.  MSFT fit that bill, and has been a name that we have been consistently bearish on for the last 2 years.  SO when asked by one of CNBC’s Fast Money producers for the Aug 13th show whether I could be the Bear, in a Bull/Bear debate on the stock, here was my response after doing a little work on the name:

From: Dan Nathan
Sent: Tuesday, August 13, 2013 9:56 AM
Subject: Re: Street Fight: MSFT

fearful of being too bearish on this one at mid point of the range since April given all of the Sept call buying of late, someone thinks they know something or just adding juice to a long…..but over 200k of the sept 35 calls were bought last week….not a ton of time to earn that out….

So the simple acknowledgement that some peeps out there are speculating on a stock that has seen little by way of speculation in years spooked me a bit…..but again, was just one data point in a laundry list of items that we go through in our trade vetting process.

With MSFT’s immediate pre-market pop Friday morning, I just had to Tweet the following, which got a fairly immediate visceral response from our followers.  Simply put, the little guy felt, as was my first inclination, that someone knew something they were not supposed to know:

$MSFT someone got the nod on Ballmer, Aug 7, Sep 32, 33 calls bought in size & Aug 8 150k Sep 35 calls bought for .14 w/ no aparent catalyst

— Dan Nathan (@RiskReversal) August 23, 2013

Now to be fair, MSFT does have an analyst meeting scheduled for September 13th (here), and the call buyers could have easily been speculating on published media rumors of some sort of break-up of the company or Ballmer’s dismissal.  This sort of speculation is not that uncommon in and around potentially market moving events, but again, this is MSFT, a stock that has been rangebound for almost 13 years.  My sense is that a large hedge fund who is long decided to “take a shot”, albeit a low probability shot that the analyst day could provide a catalyst and that defining there risk with low premium calls to lever up the position was the cheapest and easy way to do so.  IN a market environment where active managers have underperformed the broad market, these sorts of leverage strategies are not uncommon, but that doesn’t mean you should follow the whales into any old trade.  Once in a while, the lotto ticket hits – though in MSFT’s case, it all looks a little too well-timed for your run-of-the-mill long-shot bet…