MSFT shares have been on a bit of a roller-coaster ride this year, as have been their investors, employees and their customers for that matter. Despite all of the negative sentiment, regarding the declining PC market, product misses like Surface and the recent acquisition of NOK’s handset business, the stock has kept pace year to date with the Nasdaq’s gain of 23%.
The one year chart (below) is interesting to say the least when you consider 3 gaps averaging 7.5% in just the last 2 months. The series of lower highs and lower lows since making new 6 year highs in July could result in a retest of the uptrend line that has been in place since Jan of this year.
Next week MSFT will hold their annual financial analyst meeting on Sept 19th at 4pm est and the options market is implying about a 3.2% move based on the weekly at the money 33 straddle offered at ~$1.06 (stock ref $33). This is a fairly large move for event by a company who is presided over by a lame duck CEO. Our sense would be to fade the recent bounce as a new CEO announcement is likely to take months. Given the fact that the decision on who the board chooses to turn the company around may determine the company’s relevance for years to come, it wouldn’t make a lot of sense for the board to approve any other significant corporate actions prior to the new chief taking the reigns. MSFT will be unable to attract the sort of turnaround artist that it will take (recent rumors of Ford’s Alan Mulally) to right the ship, if they do not let him/her set their own agenda.
Earlier today we took off a trade in MSFT that we had established after the Ballmer resignation news hit in late Aug, causing a spike in implied volatility in the stock. The position was supposed to benefit from what we expected to be a decline in implied volatility over the coming weeks, which we got, but the NOK acquisition news sent the shares lower, through our desired range which made the trade less attractive vs the original thesis.
The stock is now up close to 7% since last weeks lows following the NOK announcement and I want to set up a trade that fades the implied move in MSFT for next week’s event, but helps finance owning puts in Nov for their fiscal Q1 earnings confirmed on Oct 24th, which we think will show continued weakness shown in their Q4 results in July.
Trade: MSFT ($33) Bought Sept / Nov $32 Put Calendar for .73
-Sold 1 Sept 32 Put at .17
-Bought 1 Nov 32 Put for .90
Break-Even on Sept Expiration:
Profits are maximized at $32 on Sept expiration (next Friday). Slight moves above and below that strike are also profitable with big moves higher or lower putting the structure at risk of losses on expiration.
Max risk is the .73 , while the potential loss of all is very unlikely unless there was a massive move higher.
Next Friday if the stock is at or above $32, but not too far above I will look to once again spread the Nov Puts that I own by rolling the calendar or by turning into a vertical.
Trade Rationale: This structure is slightly short delta, in line with our view that MSFT’s existing management and board will not have too much to say next week that will cause investors to bid the shares too much higher in the near term. Q1 earnings will be the next real catalyst for the shares, while the looming announcement of a new CEO will be the one that causes the next 10-15% in either direction (unlikely to be before Nov Expiration).
The vol differential between Sept and Nov is currently a few points, which is not insignificant given the short dated nature of the Sept puts that I am short. But It is our belief given the uncertainty surrounding the timing and choice of the next CEO that MSFT (which is normally a relatively low vol name) should see higher than usual IV, which support our thesis for owning, but also financing the purchase of Nov Puts that capture Q1 earnings.
The chart below of 1 year 30 day at the money IV shows MSFT near the highs of the year, we think it stays bid in the low to mid 20s.[caption id="attachment_30246" align="aligncenter" width="589"] MSFT 30 day at the money implied vol from Bloomberg[/caption]