Shares of Microsoft (NASDAQ:MSFT) continue to climb seemingly unabated, making yet another new all-time high yesterday. Microsft stock is now up 32% year to date, far outpacing the gains for the S&P 500 and the Nasdaq 100. But all good things eventually come to an end, at least temporarily. Expect the red-hot rally in MSFT stock to cool over the coming weeks.
Microsoft is at the highest valuations by far over the past five years. The current P/E of 53 is well above the 5-year average of 31. The forward P/E of of 26 is also at an extreme. Similar metrics, such as price to sales and price to cash flow, are also at the highest levels over the past five years. It is getting more and more difficult to justify such lofty multiples, especially given that Microsoft stock now sports a market cap over $850 billion.
Click to Enlarge MSFT stock also it an extreme on a techncial basis. Shares are overbought on 5-day RSI with a reading over 75. Previous times when Microsoft stock was this overbought marked significant short-term tops in the stock. MSFT is also trading at a large premium to the 50-day moving average of $107.61.
Prior instances when Microsoft was at such big premiums ineveitably lead to a pullback in the stock back towards the 50 day moving average.
Yesterday also saw shares fail to keep building on the intraday highs above $113.50. This type of reversal is many times a sign that the rally may be getting exhausted.
Implied volatility (IV) in MSFT options is below average at the 35th percentile, which still makes option prices somewhat cheap. So to position for a pullback in Microsoft stock, a put calendar spread trades makes sense.
MSFT Stock Trade Idea
Buy MSFT Oct $110 puts and sell MSFT Sep $110 puts for a $1.25 net debit.
Maximum risk on the trade is $125 per contract. Ideally Microsoft stock closes near the $110 strike price at September expiration to realize the maximum gain. The trade structure also allows additional selling of weekly options against the position to further lower the initial cost.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.