The cash-cow tech giant reports earnings this week, and a big move could be right around the corner. Here’s how to make a huge return on Microsoft no matter which way the stock moves after earnings.
It may not seem like it, but we’re back in midst of earnings season and about to hit the busiest couple weeks of reporting. This earnings period kind of snuck up on us, probably because most investors are distracted by numerous geopolitical events grabbing all the headlines.
Nevertheless, we don’t want to ignore earnings season, as that’s when options traders can make some of their most profitable trades of the year. Typically, we get plenty of big moves in stocks depending on who misses or beats expectations, and by how much.
One upcoming earnings report I’m currently focused on is Microsoft (NASDAQ: MSFT) on April 27th, after market close. The software king has seen a resurgence is recent months and is back to being the third-highest valued company on US exchanges.
MSFT is no longer just the creator of Windows. The tech giant is heavily involved in everything from video gaming to augmented reality. Don’t forget, the company also purchased business networking leader, LinkedIn, not that long ago.
As you can see from the chart, MSFT has had a strong run over the last year or so.
The share price is at its 52-week high of just over $66, and is well above the 52-week low of $48. On the other hand, the stock hasn’t seen much action over the last couple months, and continues to sit right around the $65 mark.
The lack of action seems to be setting up for a big move, one way or another. Investors don’t seem to know what to do with the stock, and are apparently waiting for earnings to give them a nudge.
However, the options market (based on the price of the at-the-money straddle on earnings week) only believes the stock will move about $2.80 (in either direction) post earnings. That’s a relatively minor 4.3% move. It doesn’t exactly support my thesis about investors waiting for earnings to make a buy or sell decision.
The thing is, over the last two years, MSFT’s actual move has been at least double the predicted move the day after earnings – on 4 separate occasions. On 3 other occasions, the stock moved almost exactly as much as the market predicted. Only in one instance did the stock move less than the prediction. In other words, it’s a pretty safe bet that the stock move will outperform the expectations (either higher or lower).
To put it plainly, I think the options market is wrong about the predicted move, and its guess is too small.
As I mentioned earlier, the predicted move is calculated by looking at the at-the-money straddle which expires on the week of earnings. As a reminder, the straddle is just another name for buying the call and put at the same strike in the same expiration period. As of this writing, the at-the-money straddle is the 66.50 straddle, and it’s priced right around $2.80.
That means it would only cost you $280 per straddle to bet MSFT will move more than 4.3% immediately after earnings. Another way to look at it is the breakeven points for this trade are $63.70 and $69.30 (the strike plus and minus the premium for the straddle).
Because I think the options market is underpricing investors’ reaction to earnings, I think the expiration week straddle is a good purchase. After all, $280 per straddle is very reasonable price to pay for a $66 stock. A move to $71 or $61 (both less than 10% in either direction) would nearly double your investment.
If you decide this strategy is right for you, make sure you make the trade soon. After next Thursday, the ship will have sailed. And don’t forget, the next day, Friday, is expiration – so you’ll want to take your profits (ideally) off the table by the end of the day.