On paper, it was a great quarter for Microsoft Corporation (NASDAQ:MSFT). And the outlook for business appears equally strong. But on the price chart, conditions continue to be more trying for Microsoft stock bulls in a less-friendly trend. But this trend can be made more agreeable with a creative spread combination using MSFT’s put and call markets. Let me explain.
It’s been a few days since Microsoft stock delivered an all-around solid earnings report worthy of making a bull blush — and apparently cringe too. The tech giant surged higher this past Friday as investors collectively cheered the company’s solid 16% sales growth led by Microsoft’s intelligent cloud business.
Alas, while the cloud looks great for Microsoft’s future business growth, the ‘sky is not the limit’ on the price chart. MSFT shares have proceeded to take back the entirety of those gains over the last couple sessions. So, what’s next and what’s a bullish Microsoft stock investor to do?
I’m glad you asked.
Microsoft Stock Daily Chart
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Trend persistence for nearly 1.5-years following Microsoft’s key breakout to all-time highs has turned into volatility over the last three or so months. This volatility has resulted in multiple breakdowns and reversals through the well-watched 50-day simple moving average (the yellow line on the chart) and increased risk for MSFT investors.
Microsoft stock’s current correction is more time-based than price-based. I personally favor the latter type of reset in a stock after a strong rally like the one in MSFT. However, regardless of how a consolidation plays out, its generally a welcome event which can remove excessive optimism and eventually lead to a healthier technical platform for fresh highs.
The bad news is Microsoft doesn’t appear to be ready to move higher at the moment. Maybe worse, by purchasing MSFT shares prematurely there’s always the risk a time-based correction could turn more trying for intrepid bulls if the stock begins to experience a deeper, price-based pullback.
Microsoft Stock Bullish Combination
Personally, I like the idea of being an opportunistic buyer of MSFT stock if it traded lower. But I’ll be the first to admit I don’t know if the current correction will turn lower or result in a breakout after a bit more time-based consolidation. The good news: I have a reduced and limited-risk spread combination that fits the situation nicely.
A modified butterfly call spread involves calls at three strike prices. You sell 3 calls at the middle price, while simultaneously buying two calls at a higher price and one call at a lower price. From lowest-to-highest strike price, this gives you a 1:3:2 ratio.
With shares of Microsoft at $93.51 (as of this writing), buy the July $97.50 / $105 / $110 modified butterfly call spread. Simultaneously, sell the July $85 / $80 put spread. Right now, this is priced for a debit of 70 cents.
On the upside, if MSFT begins to rally the net position has an expiration break-even of $98.20. Prior to the contract’s maturity, the spread can also begin to accrue profits below the break-even level due to time value.
The maximum profit capture is $6.80 at $105. Also, unlike a regular butterfly this combination’s risk is contained to a slighter profit of $1.80 above $110 and not a loss of the debit. Nice, right?
Alternatively, if Microsoft stock heads lower, risk is contained to $5.00 — or the width of the sold put spread. That amounts to roughly 5.5% of the holding risk associated with purchasing shares today. The contained risk is nice to have in place, but it gets even better.
Bottom Line for MSFT Options
The trader of this spread has a discounted entry of $85.70 — 8% below the current share price.
What’s more, if a price-based correction was to unfold and conditions became really nasty, this trader isn’t obligated to buy MSFT. But if the decision to get long Microsoft stock is made, the end result could be an even healthier entry point due to the defined risk insurance policy of this position.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. . For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits.
