I recently went long Microsoft Corporation (NASDAQ:MSFT) by selling puts, and that trade delivered easy profits. I still like the set up, but since I didn’t sell the calls for balance I want to book the profits and reset the risk.
Microsoft’s management has proven to me that they can adapt. It is impressive for a company of that size be able to turn the ship around to thrive in the new technological realities that we currently have.
I offer the opposite example from the failure of International Business Machines Corp. (NYSE:IBM) at finding their new groove.
Microsoft stock has recently had an impressive rally, so I have to make sure that my goal today is not to chase a price target. Instead, I will commit to buying the shares, but at a much lower price.
Click to Enlarge Fundamentally MSFT stock registers as expensive from a price-to-earnings perspective, but I am not worried about a 31 trailing P/E since the company has high margins and pays a dividend. Compared with Salesforce.com Inc’s (NASDAQ:CRM) near-480 P/E, Microsoft is a bargain.
More concerning to me than the high P/E is analyst expectation. Those are lofty, with mostly buy and outperform ratings. The risk of downgrades is elevated, but the effects of a potential re-rating should be short in nature. Unless a new threat emerges, if MSFT stock catches a downgrade the stock could fall for a day or two but the underlying move should then resume.
MSFT Stock Trade Idea
The Thesis: I am confident that in this animal-spirited equity market Microsoft will be a leader among the mega-caps. It is highly unlikely that it would correct 20% on its own. And if it does, I am willing to own its shares that low.
The Trade: Sell MSFT Dec $55 puts and collect 60 cents per contract. This is a bullish trade that doesn’t require a rally. I retain maximum gains as long as price stays above my sold puts. Otherwise I own the shares and liable to suffer losses below $54.40.
To lessen the risk I can use spreads instead.
The Milder Alternative: Sell the MSFT Dec $60/$55 credit put spread for 50 cents, where I have a slightly smaller chance of success but with limited risk. Yet, the trade would yield 11% on risk. Compare this with risking $70.50 today with no room for error then needing the stock to rally another 11% just to match the performance of the spread.
Selling options is risky business, especially near all-time market highs, so I only risk money I can afford to lose.
Learn how to generate income from options here. 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. You can follow him on Twitter at @racernic and stocktwits at @racernic.
