Shares of Microsoft (NASDAQ: MSFT) have been somewhat forgotten among all the recent tech stock talk over the past few months. MSFT stock is up over 21% so far this year, far outpacing gains in both the S&P 500 and Nasdaq 100.
Microsoft just closed at an all-time high and broke past the $800 billion market cap level for the first time ever yesterday. While momentum players are rejoicing, both the fundamentals and technicals show that the red-hot rally in MSFT stock has come too far, too fast. Expect a post-earninsg pullback in Microsoft.
Click to Enlarge After holding support at the $97.25 area in late June, MSFT stock has been on a monster rally, moving 7% higher over the past 10 trading days. Microsoft stock broke out to fresh new all time highs yesterday but is getting overbought with nine-day RSI readings over 70. Previous instances when Microsoft reached these levels marked significant short-term tops in the shares.
MSFT is also trading at a big premium to the 50-day moving average at $99.21, another sign the the rally may be getting a little frothy.
Earnings are due on July 19 with expectations for $1.07 EPS and $29.17 billion in revenue. The whisper number, or what analysts really think, is $1.12. While both earnings and revenues are growing, multiples are expanding at even a faster pace. MSFT stock is trading at the richest valuations over the past five years on both a price to earnings (27.93) and price to sales (8.18) basis.
Click to Enlarge Given that Microsoft now sports the fourth-largest market cap of all U.S. stocks, I think the law of large numbers will begin to apply and growth will necessarily slow simply due to the sheer size of Microsoft. Paying such rich valuations considering that backdrop definitely give some pause for concern going forward. I look for the rally to stall out near current levels.
Implied volatility (IV) is elevated in front of earnings on July 19, meaning option prices are comparatively rich, especially in the traditional July expiration that expires July 20. So to position for a pullback in MSFT stock, a put calendar trade makes probabilistic sense.
MSFT Stock Trade Ideas
Buy MSFT Aug $100 puts and sell MSFT July $100, puts for an 80-cent net debit or better.
Maximum risk on the trade is $80 per spread. Ideally MSFT stock closes near $100 at July expiration to realize the maximum potential gain. The trade has a decided term structure of volatility edge with the August options that we are buying trading at a 23% IV while the July options we are selling are priced at a much higher 33% IV.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.
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