Microsoft is a highly rated stock that has pulled back to the 50-day moving average and could be due for a pause here.
Microsoft stock is still above an upward sloping 200-day moving average and has not shown much distribution during this recent pullback.
However, with the markets looking a little fragile, sideways action may be the more likely scenario.
A calendar spread is one way to play this thesis, while also taking advantage of the volatility skew around next week's earnings report.
A calendar spread is an income trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Usually, this is done with monthly options, but it can also be done with weekly options.
Is Microsoft Stock A Buy Now? Here's The IBD Take
Microsoft Stock Calendar Spread
Traders typically use call options unless the trade has a bearish bias. In that case, they would use puts.
In today's example, we'll look at a calendar spread trade on Microsoft stock. On Monday, shares in Microsoft stock rose nearly 1.6% to 443.71.
With Microsoft stock trading around 440, setting up a calendar spread at 440 gives the trade a neutral outlook.
Selling the Aug. 2 call option with a strike price of 440 will generate around $1,140 in premium, and buying the Aug. 16, 440 call will cost approximately $1,335.
That results in a net cost for the trade of $195 per spread, and that is the most the trade can lose.
The estimated maximum profit is $875, but that could vary depending on changes in implied volatility.
The idea with the trade is that if Microsoft stock stays flat after the earnings announcement, the sold option will decay faster than the bought option. That would allow the trade to be closed for a profit.
The break-even prices for the trade are estimated at around 414 and 475, but these can also change slightly depending on changes in implied volatility.
Microsoft Stock Trade Exit Strategy
For this reason, calendar spreads are considered a more advanced strategy and not recommended for beginners.
For a trade like this, I would set a profit target of 30%. And I would set a stop loss if Microsoft stock breaks through either 410 or 480.
The main risk with the trade is that Microsoft is due to report earnings on July 30, and the options market is pricing in a potential 5.6% move in either direction. Calendar spreads are a neutral option trading strategy.
Microsoft stock is ranked No. 1 in its industry group. It has a Composite Rating of 84, an EPS Rating of 97 and a Relative Strength Rating of 79.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
