Option traders are stocking up on long (purchased) puts in Microsoft (NASDAQ: MSFT), expecting a sharp move lower in a relatively short period of time. With just three weeks until March expiration, the March 27-strike puts are notably active Friday. In fact, the contracts trading on this front-month option represent about 40% of all options activity in the stock today.
Nearly 45,000 contracts have changed hands today against open interest of just 7,615. The vast majority of today’s volume, then, must consist of new positions that will likely translate as new open interest Monday morning.
It looks as though much of this unusual volume hit the tape as one block trade that traded for 4 cents per contract. Four cents certainly sounds like a drop in the bucket, but that adds up to roughly $175,000 when 45,000 contracts are involved. It suggests that the trader in question is willing to risk a very small amount (on a per-contract basis) in the hopes that MSFT takes a pretty serious tumble between now and March 17.
For these long out-of-the-money puts to be profitable at expiration, MSFT would need to be trading below the breakeven price of $26.96 (the strike price of 27 less the premium paid for the puts). That’s a decline of 14% from the stock’s current level of $31.40. What’s more, MSFT shares have not traded below the 27 level since early January.
If the stock does drop this much, potential profits are theoretically unlimited down to the zero mark (through March expiration). If it stays put (or even declines “only” 13%), the put buyer risks losing the entire premium paid.
An option’s price is based on more than just the movement of the underlying stock; it involves factors such as dividends and time until expiration. So, there’s a small possibility that today’s massive put buy is a volatility play. An increase in Microsoft’s implied volatility could lift these low-priced options enough to make it worth the buyer’s while.
But here’s the rub: Little evidence suggests MSFT volatility will swing higher. In fact, the stock’s implied volatility has been on a downward trajectory since October (see chart) and isn’t far from a 52-week low. Company earnings aren’t due out again until April 19, so that would not impact these March-dated options.
Either way, it’s quite the long shot. The delta of these options is currently 3%. This “Greek” can be interpreted one of two ways, neither of which is pretty. First, it means that for every one-dollar move lower in MSFT shares, the option will rise by a penny. It also reflects a 3% chance that this option will be in-the-money by the time expiration rolls around. Deltas typically drop as expiration approaches, as time value erodes.
As of this writing, Beth Gaston Moon does not own any shares mentioned here.
