Event: MSFT reports its Fiscal Q2 earnings today after the close. The options market is implying about a 4.75% one day move, which is below the 4 qtr avg of about 5.5% but in line with the 8 qtr avg of about 4.75%.
Sentiment: Wall Street analysts have been relatively mixed on MSFT, with 16 buys, 21 holds and 3 sells, with an average 12 month price target of $38.36. The stock has actually been a strong performer over the past year, up 34%, though it has started 2014 on a negative note, down 4% so far this year. Short interest is negligible at 1% of float.
Options Open Interest: Calls outnumber puts in total open interest, by a ratio of 1.5 to 1 (1.47m calls vs. 0.99m puts). The one month average volume has also favored calls, at a ratio of around 1.6 to 1. Dan mentioned the stock in TMO on Jan 8th:
MSFT – on a day that saw considerable weakness relative to its large cap tech peers, down 2% on news that Ford CEO Alan Mulally pulled out of the running to replace MSFT CEO Steve Ballmer, there was a good bit of call buying. Calls outnumbered by puts by a factor of 2 to 1, with the largest blocks a buy of 18,
000 Feb 38 calls for . 44 to open and a buy of 12k Feb 7th weekly 37. 5 calls for . 45.
The following strikes have over 30k of open interest:
-Jan31st 37 calls
-Feb22nd 38 calls
-Feb22nd 40 calls
-Apr 31 calls
-Apr 33 calls
-Apr 37 calls
-Jan15 30, 35, 37, 40, 42, and 45 calls (the 35 and 37 calls have over 100k of open interesT)
-Jan15 25, 28, 30, 32, and 35 puts
-Jan16 30 puts
-Jan16 40 calls
Price Action / Technicals: MSFT made a new 10 year high in November, breaking above the $37.50 high from November 2007. However, the stock was unable to hold on to that breakout, breaking back below that level in December. MSFT is now in a short-term downtrend with a series of lower lows and lower highs since its December 4th high:
The 50 day moving average around $37.15 is now downward sloping and is initial resistance on the upside. The January low of $34.63 is near the rising 200 day moving average around $34.30, and that area is initial support.
Fundamentals/Valuation: MSFT has been a battleground stock among tech traders for the past 15 years. A stock that has made little headway overall, but always a strong bullish or bearish argument to be made. Market participants responded positively to the company’s October earnings report after significant growth in the Commercial Cloud (Office 365 migration) and nothing too terrible in the legacy software and hardware businesses (though not great either.
Here is what the GS analyst said about the expectations for the stock (granted, GS is one of the few with a sell on MSFT):
While we expect Microsoft to benefit from better than expected PC sales driven by the end of life in XP at the end of C1Q14, we nonetheless see FY14 and FY15 EPS estimates moving lower as a result of material gross margin pressure from Microsoft’s migration to a devices and services company. Furthermore, we believe the next CEO, when named, will continue down the path of the recent reorganization, which puts a divestiture of Microsoft’s online and entertainment assets as having a low probability in the near term.
However, we tend to agree that the overall direction of the technology industry is counter to MSFT’s core strengths. The stock’s valuation is cheap at around 13x, but with only 5% earnings growth expected over the next 3 years, there is not much cushion in that multiple if MSFT earnings or guidance disappoints.
Volatility: Implied volatility in MSFT, in contrast to the most of the broader market, is actually near 2 year highs ahead of today’s earnings event:
Part of that is due to the recent large moves in MSFT after earnings (+6% in October and -11% in July). But part of the elevated implied volatility level is also due to the expectations for an announcement of the identity of the new CEO at some point in the next month. The market’s perception of that appointment could mean a big move in either direction.
Our View: The headlines in MSFT have recently been focused on who would be named as CEO. In the midst of that discussion, the underlying trends in MSFT’s business have not been in focus. It’s those underlying trends that have us skeptical about the long-term prospects for MSFT stock, with the management shuffle simply another wrench in the behemoth’s growth.
Implied volatility is relatively elevated, and MSFT is in the middle of its 34-37.50 range, so we might look at range trade structures, though our bias is to the downside after earnings, with the caveat that the CEO announcement could be a cause for a near-term pop.