Trade Ideas October 27, 2020

Microsoft (MSFT) FQ1 Earnings Preview / Trade Ideas

by Dan

Microsoft (MSFT) will report its fiscal Q1 results today after the close. The options market is implying about a 4.5% one day move tomorrow. The weekly at the money Oct 30th 212.50 straddle (the call premium + the put premium) is offered at about $9.50, or about 4.5% of the stock price, if you bought that and thus the implied move you would need a rally above $222 or a decline below $203 by Friday’s close to make money. Shares of MSFT have only moved about 2.25% on average the day following their last four earnings reports, which includes a 4.35% decline following their Q4 results in late July.

MSFT stock is up nearly 35% on the year and up nearly 62% from its March lows, sporting the third highest market cap in the U.S. at $1.6 trillion behind Apple’s (AAPL) $2 trillion and just below Amazon’s (AMZN) $1.63 trillion. It is truly astounding that these three companies make up $5.25 trillion in market cap.

Near-term technical resistance is near $225 its Oct high and then the Sept 2nd all-time high near $233, but to my eye, this chart looks like a textbook head and shoulders top with $200 as the neckline. The stock found support yesterday at its 100-day moving average (green) and is today still below its 50-day moving average (purple) while its 200-day down near $190 would be a clear downside target if the stock were to break the neckline:

 

Wall Street analyst remains overwhelmingly bullish on the stock with 31 Buy ratings, 5 Holds and no sells with an average 12-month price target of $237.

My friend and Fast Money guest Jared Weisfeld, Tech specialist over at Jeffries offers the following setup into tonight’s print in a note to clients this morning:

This is a big quarter for MSFT. Taking a step back, MSFT posted a disappointing June quarter with key metrics decelerating across the board. Office Commercial 365 revenue growth decelerated 500bps sequentially to 22% y/y CC growth due to SMB weakness, Azure growth decelerated by >1,000bps to 50% CC, and Amy messaged that FY2021 would be an investment year and not one of operating margin expansion (vs. ~300bps expansion in FY2020). Microsoft shares were under pressure after last quarter’s print, down ~4% to the $200 level. The stock proceeded to break-out to the $230 level after the TikTok drama worked its way into the stock before retracing back to $210 into this evening. As investors continues to worry about Office Commercial and Azure deceleration, MSFT shares have lagged, +3.7% since the last print vs. the QQQs +9% and IGV +11%, so is this the quarter where we get some reversion? As per a typical MSFT print these days, all eyes are focused on the Azure’s constant currency y/y growth. Consensus is sitting at 43% and buyside is at 46% (see below). Although those close to the name are worried given the implied sequential dollars required to hit that y/y growth. Other factors to consider include recent PC strength given strong consumer PC demand (low-end, check out INTC’s recent results) and whether we’ll see a continued slowdown in Office 365 similar to last quarter.

I suspect the company disappoints once again on their outlook, taking into account the INTC results and yesterday’s guide down by enterprise software vendor SAP (read here).

So what’s the trade?

Long holders who do not want to sell their stock, but are more worried about downside associated with their earnings/guidance and post-election volatility should consider collars, selling 1 out of the money call (per 100 shares long) and using the proceeds of that sale to help finance the purchase of a downside put, essentially limiting potential upside in the sock between now and the chosen expiration to the short call strike, but also limiting losses in the stock down to the long put strike, for instance:

vs 100 MSFT shares long at $213 Buy Nov 20th 200 – 225 collar for even money

-Sell to open 1 Nov 225 call at $3.90

-Buy to open 1 Nov 200 put for $3.90

Break-even on Nov expiration:

Profits of the stock up to 225, if the stock is 225 or higher on Nov 20th expiration the investor’s stock would be called away, but the investors can always buy to cover the short call to keep the long stock position intact.

Losses of the stock down to 200, protected below. if the stock is at or below 200 on Nov 20th expiration the investor will need to make a decision whether they want their stock to cover the long put, so again will need to make a decision whether they want to stay long.

Rationale: an investor would collar their stock into an event like earnings, or into a period of uncertainty like the post-election days/weeks if they have gains they want to protect down to a certain point and they are more willing to give up potential gains in place of having defined risk to the downside.

 

Or If I were looking to express an outright bearish view with defined risk I would consider put spreads in the weeklies, but you know my take on this sort of trade, you need to be very convicted because you need to get a lot of things right to just break-even, first and foremost direction, the magnitude of the move and timing.

Bearish Trade Idea: MSFT ($213) Buy Oct 30th 210 – 195 put spread for $2.90

-Buy to open 1 Oct 30th 210 put for $3.20

-Sell to open 1 Oct 30th 195 put at 30 cents

Break-even on Friday’s close:

Profits of up to $12.10 between 207.10 and 195 with max gain below 195

Losses of up to $2.90 between  207.10 and 210 with max loss above 210

Rationale: this trade idea risks 1.4% of the stock price for the next 3 trading days, with a break-even down 2.8% a little more than half of the implied one day post-earnings move, and a max gain of 5.7% of the stock price if the stock is down 8.5% by Friday’s close.

 

And Lastly, if I were inclined to lean bullish with defined risk, but think the stock rallies a bit but has greater potential after the rest of tech earnings are out of the way and after the election then I might consider call calendars, selling one short-dated out of the money call and using the proceeds to help finance the purchase of one longer-dayed out of the money call of the same strike, for instance:

Bullish Trade Idea: MSFT ($213) Buy Oct 30th – Nov 20th 225 call calendar for $3

-Sell to open 1 Oct 30th 225 call at $1

-Buy to open 1 Dec 225 call for $4

Break-even on Friday’s close:

The ideal scenario is that MSFT is near $225 on Friday’s expiration, if below the short call will expire worthless and you will be left long the Nov 225 call for only $3 cents as opposed to the $4 it costs now. If the stock is at or above the 225 strike then the short call can be covered if you want to stay long the Nov 225 call. The idea of the trade idea is to reduce the outlay for the longer-dated call, targeting the implied earnings move, and setting up for a larger rally over the next 3 weeks.

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