Microsoft is due to report earnings on Thursday after the closing bell. It's useful to use the options market to gauge an expectation for the earnings move. For Microsoft stock, that's looking like a 4.4% move in either direction.
Since Microsoft stayed above the lower expected range in five of the last six earnings announcements, we'll structure a bullish trade that captures premium with the higher implied volatility.
We are looking at a view that:
- We think Microsoft will stay within the expected range.
- The response to the earnings report is likely to be positive.
Creating The Bull Put Spread
A rough estimate for expected earnings relies on the options market for the calculation. You start by taking the premiums for an at-the-money put and call at the nearest expiration after earnings. For Microsoft, earnings are after the close on April 25 so we'll use the April 26 expiration. Taking the sum of those two premiums is 17.80 with Microsoft trading around 407.50. That gives us an expected range of 4.4% in either direction.
Now that we know the expected range, let's find a bull put spread that has the short strike roughly 4.4% below the stock price.
Selling the April 26, 385-strike put and buying the 380 put would create a bull put spread.
This spread is trading for around 65 cents today. That means a trader selling this spread would receive $65 in option premium and would have a maximum risk of $435.
That represents a 14.9% return on risk between now and April 26 if MSFT stock remains above 385.
If MSFT closes below 380 on the expiration date, the trade loses the full $435. That gives Microsoft a lot of room to come down and still give us maximum profit on the trade.
Managing The Trade On Microsoft Stock Option Play
The break-even point for the bull put spread is 384.35 which is calculated as 385 less the 65 cent option premium per contract.
But there is little room for adjustment with short-term trades such as this held over earnings.
A 14.9% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high risk tolerance.
If MSFT stocks ends below 380, long-term investors could consider taking ownership of the 100 shares and selling covered calls against them.
According to IBD Stock Checkup, Microsoft stock is ranked No. 1 in its industry group. It has a Composite Rating of 85, an EPS Rating of 97 and a Relative Strength Rating of 82.
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
