New Trade – $MSFT: Tick in a Xbox

by Dan August 3, 2015 2:10 pm • Commentary

Regular readers know that we try not to get sucked into investment ideas with buzz-phrases like cloud transition, upgrade cycles, back to school etc etc… that’s all mumbo jumbo that technology investors over-use in an attempt to manufacture catalysts for the stocks that they already own.  Shares of Microsoft (MSFT) have recently been painted with all three of these terms, despite the backdrop of what appears to be an already weak and weakening environment for both consumer and corporate PCs. Given the results and guidance from others in the PC supply chain it seems unlikely that the future benefits of MSFT’s transition from clients to their cloud based Office 365 can keep the stock buoyed here, and neither can the love affair with new CEO Satya Nadella.  I think its safe to say that the stock trading at 17.4x fiscal 2016 earnings (ex $65 billion in net cash below a market multiple), it highest multiple since 2009, already reflects a most if not all of this optimism:

MSFT 7 year chart of P/E from Bloomberg
MSFT 7 year chart of P/E from Bloomberg

From purely a technical standpoint, the stock has been range-bound for most of the past year, trading between $50 on the upside, and almost as low as $40 on the downside, with the average price almost smack dab in the middle at $45.41:  

[caption id="attachment_55830" align="aligncenter" width="600"]MSFT 1yr chart from Bloomberg MSFT 1yr chart from Bloomberg[/caption]

Options prices appear to be fairly cheap, with 30 day at the money implied vol at 18.4%, essentially in line with its realized vol that has been picking up over the last month.  The one year chart of ATM IV shows higher lows and higher highs, which could be a mild reflection of vol picking up in tech stocks as a group, but also of the 20% range the stock has traded in during that period:

[caption id="attachment_55832" align="aligncenter" width="600"]MSFT 1yr chart of 30 day at the money IV from Bloomberg MSFT 1yr chart of 30 day at the money IV from Bloomberg[/caption]

The stock is unchanged on the year, under-performing the Nasdaq Composite which is up 7.5% on the year, so there is some skepticism built into the stock, but that could also be viewed as complacence with what’s going on in the rest of the PC chain (see INTC).

The next identifiable catalyst will not be until Q1 results already scheduled for October 22nd.  We want to finance owning downside puts for that event in the near term as the stock could be a range-bound as it has been. Therefore we’re doing this put calendar to help bide some time:

Trade: MSFT ($46.63) Buy to Open 1 Aug / Nov 45 Put Calendar for 1.40

-Sell to Open 1 Aug 45 put at .30

-Buy to Open 1 Nov 45 put for 1.70

Break-Even on Aug Expiration:

Profits: The ideal spot for this trade on August expiration is the 45 strike. It would be profitable there and the short put portion would able to be rolled.

Losses: Any move higher from here would likely result in small losses into August expiration with a big move back towards the highs in the stock with significant losses to the 1.40 risked.

Rationale: MSFT could join other stock in the PC chain in under-performing the broader market. However, with no catalysts until November expiration it makes sense to finance the purchase of November puts by selling the dog days of August with the August 45 put. If we do see continued consolidation we will be set up well and have a couple of different options to further spread the November puts.