Microsoft Corporation (MSFT) has been a darling of Wall Street of late. Microsoft stock has recently broken out on a technical squeeze and fell just short of its all-time highs.
Long term, MSFT should prosper and the stock should continue higher. I believe that the new subscription model should give them better control over pricing and piracy.
But short term, I want to cautiously short MSFT stock. Markets in general seem top-heavy, which better my odds of winning.
Click to Enlarge The easiest way to short a stock is to buy put options in it. Shorting a stock outright leaves me open to unlimited losses. Buying puts allow me to short Microsoft stock with a well-defined risk.
When buying puts, it’s important to choose the correct strike price. Often traders fail not so much for guessing the direction wrong but for choosing the wrong time or level. I like to buy puts at the money and with some time on the clock so I only need to guess direction and not magnitude. If MSFT stock falls, I immediately start to profit.
Puts that are at the money are more expensive than ones that are far below current price. But if I am buying puts too far below current price, I could still lose even if I guess the right direction of the move.
Two Trades for MSFT Stock
Trade No. 1: I buy the April $54.50 put. For this I pay 65 cents per contract to open. I chose the April put hoping to avoid the earnings, as I am not shorting the MSFT fundamentals but rather the Microsoft stock level at this point in time.
Trade No. 2 — Optional: Since I believe in MSFT’s future prospects, I want to finance the aforementioned short-term puts by selling longer-dated puts. I sell May $50 put and collect 65 cents per contract.
When taken together, the two trades make it possible for me to profit most if MSFT stock falls to $50 per share in the next 10 days then rebounds. Since there is no out-of-pocket expense it will be easy to turn a profit as long as Microsoft stock falls but doesn’t crash past $50 per share.
There are hundreds of variations to this pair trade, but by selling the naked puts, I am willing to buy MSFT stock at that strike price. I can modify Trade No. 2 to selling July $47 strike put for a bigger range for profit.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
