Event: MSFT will report their fiscal Q2 tonight after the close. The implied move in the options market is about 4.2% in either direction, below the 4 qtr average one day post earnings move of 5.6%, but just below the 10 year average. With the stock at $64, just below the all time high made earlier today, the the Jan 27th weekly 64 straddle (the call premium + the put premium) is offered at about $2.75, if you bought that and thus the implied earnings move you would need a rally above $66.75 or a decline below $61.25 to make money, or about 4.2% in either direction.
To put the implied move in perspective, that’s about a $21 billion market capitalization in either direction just tomorrow.
Price Action / Technicals: Shares of MSFT has mildly under-performed the Nasdaq year to date, up 5%. The one year chart below is a work of art, putting in an epic double bottom at $48 in Feb and June of 2016, and having risen 33% since June, all along holding the uptrend, and now once again threatening a breakout after a 6 week consolidation between $62 & $64:
MSFT 1yr chart from Bloomberg
Longer term, the stock’s breakout above its 2000 high was significant, and $60 should serve as decent near term technical support, while there is no overhead resistance above, likely just valuation levels:
MSFT since 1999 from Bloomberg
While we are on such mundane things as valuation, I would not that the stock trades nearly 22x expected fiscal 2017 eps, which is expected to grow only 6% on just 2% sales growth. The stock’s stellar balance sheet was recently depleted by their $26 billion acquisition of LinkedIn which as seen its debt balloon to $75 billion from $54 billion in F2016 and $35 billion in F2015, and more than half of its $137 billion in cash. On the cash front, a massive hunk of that is overseas, and tax reform that includes repatriation should be a huge boon for MSFT. What might they do with all that cash if it were able to come back under some sort of holiday? Well not likely hire, but they could attempt to beef up their annual dividend that sits at 2.44%, below the 10 year treasury yield for the first time in a very long time. Obviously strong price performance of the stock, and the quick rise in rates has caused this to happen, neither are horrible, but the company may well think about how they deploy their cash in a rising rate and dollar environment given their now massive debt load.
Our Take: the risk reward to committing new capital to MSFT at current levels looks challenged given valuation, dollar and rates headwinds, the potential complications of integrating LinkedIn, a widely unprofitable company on a GAAP basis and the growing competition in their strategic cloud initiatives that could see pricing pressures and ultimately commodization in the public cloud.
For those who are long, alternatives with defined risk might make sense, and clearly for those considering playing long into the print. While the implied move is less than last quarter’s nearly 6% implied move and 4.2% actual movement.
Short dated options prices are at very wide spread to realized volatility (brown below, how much the stock has been moving) with 30 day implied volatility (blue below) at 24%, vs realized at 10.5%, making long premium directional trades challenged in the event of less than expected movement:
So what’s the trade?
If I were inclined to play for the long side, or look to replace an existing long with defined exposure, I would look for a strategy that will offset the eventual crush in options prices following the event.
If I thought the stock could go up tomorrow in line with the implied move I might consider the following call butterfly:
MSFT ($64) Buy Jan 27th 64 / 66.50 / 69 call fly for 70 cents
-Buy 1 Jan27th 64 call for 1.40
-Sell 2 Jan27th 66.50 calls at 40 each, or 80 cents total
-Buy 1 Jan27th 69 calls for 10 cents
Break-Even on tomorrow’s close:
Profits: between 64.70 and 68.30 of up to 1.80, with max gain of 1.80 at 66.50
Losses of up to 70 cents between 64 and 64.70 & between 68.30 and 69 with the max loss of 70 cents, or a little more than 1% of the stock price if the stock is below 64 or above 69.