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Microsoft Corp. (MSFT) stock has tumbled recently, but is up from recent lows. Has MSFT become too cheap? After all, analyst price targets are significantly higher. One play is to sell short one-month MSFT put options to set a lower buy-in potentially.
MSFT closed at $390.49 last week, up from a recent low of $353.98 on June 25. That is also well below its 3-month peak of $460.52 on June 1. However, both my and other analysts' price targets are significantly higher.
Much Higher Price Targets for MSFT Stock
For example, my June 2 Barchart article ("Microsoft Stock Still Looks Cheap - Shorting One-Month Puts Has a 2.0% Yield") showed that, based on Microsoft's strong free cash flow (FCF) margins and analysts' revenue forecasts, it could be worth $556.77 per share.
Moreover, in a follow-up article on June 10, based on higher analysts' revenue estimates, I showed that MSFT's price target (PT) could be $580.09. That is $189.60 higher than today's price, which is +48.6% higher.
Similarly, analysts' price targets are equally high. For example, Yahoo! Finance shows that 56 analysts have an average PT of $561.11, and Barchart's survey PT is $552.27. In addition, AnaChart, which tracks recent analyst write-ups, shows an average PT of $572.79.
So, the average survey's PT is $562.06 per share. That is 43.9% above today's price and is similar to my 48.6% higher price target upside (shown above).
Nevertheless, there is no guarantee MSFT will rise to these PTs. Therefore, one conservative way to play MSFT is to sell short out-of-the-money (OTM) cash-secured puts in one-month expiry periods.
That way, an investor can get paid while waiting for MSFT to drop and to buy in at a much lower breakeven price.
Shorting OTM MSFT Puts
For example, the August 7 expiry period, just over one month from now, has a midpoint premium of $10.78 for a 5.25% lower strike price (i.e., $370.00).
That means that an investor who secures $37,000 with their brokerage firm can earn $1,078 by entering an order to “Sell to Open” this contract. That works out to a one-month yield of 2.914% (i.e., $1,078/$37,000).
The point is that this allows an investor to make money even if MSFT treads water over the next month. Moreover, if MSFT drops to 370.00, the investor's net breakeven is:
$370.00 - $10.78 = $359.22 breakeven point
That is $31.27 below last week's close, or -8.0% below $390.49. The point is that this could give an investor a huge potential upside. For example, using my original PT of $562:
$562 / $359.22 = 1.5645 -1 = +56.5% upside
This $562.00 breakeven is close to MSFT's recent low of $354, so that's another advantage.
However, the delta ratio is still high at -0.3090. That implies there is over a 30% chance that MSFT could drop to $370 by Aug. 7.
Alternative Play
As a result, some more risk-averse investors may want to short the $365.00 put option. That has a midpoint premium of $8.98, so the short-put yield is:
$8.98 / $365.00 = 0.0246 = 2.46% for one month
That is only slightly lower than the 2.914% yield from the $370 short-put play, but the delta ratio is lower at 27.2%.
Note that either way, the expected return (ER) from both of these plays over the next 6 months (assuming the same yields can be made each month) is high:
2.914% x 6 = 17.484% (ER)
2.46% x 6 = 14.76% ER
These are still lower than buying and holding MSFT, based on PTs over the next year. But, at least, with this play, an investor can potentially have a lower buy-in and also earn income while waiting.
