Tensions on Wall Street remain heightened as earnings season officially begins, U.S.-China trade negotiations kick off and the Fed is about to meet over the now-priced-in rate cuts. And that leaves one company right at the center of it all.
As the largest company in the world, Microsoft is affected by just about every macroeconomic story these days. Its assembly plants in China are at the heart of the trade war. Its $72.6 billion in long-term debt makes investors careful Fed watchers. And to top it off, the tech giant reports earnings tomorrow.
All of this has Wall Street carefully considering that $1 trillion-plus price tag Microsoft now sports. Though, despite all of this, there is one thing it has going for it its tech brethren don’t. It isn’t in the hot seat in the political Kabuki theatre of antitrust discussions.
Amazon, Apple, Facebook and Google (Alphabet) representatives sat in front of the House Judiciary Committee in Washington yesterday to defend their companies against accusations of breaking antitrust laws.
The four companies each clearly own enormous market shares of their respected areas. Yet, Microsoft – an expert on the topic – wasn’t in attendance. The tech giant had already gone through this somewhat bipartisan procedure before.
In 1998, Microsoft was found in violation of antitrust laws and ordered to make changes or be forcefully broken up. The company did comply and pay a heavy price. But clearly, it hasn’t set the company back forever.
Now, Microsoft is still the industry leader in its field. But so far, it has stayed mostly out of the antitrust discussions… for now. That, however, is about the only thing investors can say about the company’s portfolio of news troubles.
Right now, we’re seeing investors continue to buy shares of MSFT. This year has been a tremendous one for shareholders:
The company’s performance is one of the biggest reasons the Nasdaq has been hitting its all-time highs of late. But can it last forever?
There are those worried about the $1 trillion curse. Apple and Amazon played with that market cap milestone last summer before retreating hard in the year-end freefall. Microsoft, however, passed that mark earlier this year and has been able to hold on with this solid six-month rally. But as noted above, the company has a lot of outside factors that could change this in a hurry.
Now, we’re not saying the company is fated to fall anytime soon. It could. Trade negotiations break down and tariffs on an additional $325 billion worth of goods could be on the table. The Fed could defy the market and the White House and keep rates flat or cut less than expected. Or, and this could be a big one, Microsoft itself could disappoint with its Q2 earnings tomorrow.
The company has a great history of beating analyst expectations, at least in recent quarters. But both the company’s guidance and analyst estimates call for an 18.3% year-over-year growth rate during the quarter.
Plus, as the world’s largest company, many will be watching to see how sales have held up so far in this first half of 2019. With somewhat mixed economic indicators of late, consumer electronic spending at the industry leader will certain create some headlines.
So, right now, it is truly impossible to say which way shares of Microsoft will head in the next few months… or even the next few days. Fortunately, there’s an options strategy that lets traders profit even without knowing the direction of price movement.
A Strategy For Short Term Volatility
A long strangle is a type of trade that profits from volatility rather than direction. So, if you know a stock is likely to break one direction or the other – for say an earnings announcement, trade negotiation or Fed rate announcement – you can use this strategy.
The way it works is by buying an out-of-the-money call options and an equal number of out-of-the-money put options with the same strike price. This ensures that one of the two legs will turn a profit on any large price movement.
You can see how it works here:
Source: The Options Industry Council
As you can see, the risk is limited to the cost of each option. But the profit potential is unlimited. In the case of Microsoft, if something really shakes up the company over the duration of a long strangle trade, shares could move in a hurry. If they quickly rally, the call options will create the profit opportunity. If they fall, the puts will.
Let’s look at a specific example for this trade…
A Specific Trade on Microsoft
Right now, a trader could buy an August 16 $140 call option for $2.41 per share and an August $16 $135 put option for $2.70 per share for a total cost of $5.11 per share. Since each option represents 100 shares of MSFT, that’s a net debit of $511.
That is the most the trader has at risk. But he’d only lose that if shares stay between $135 and $140 for the next month. Considering all that is going on at Microsoft and the global markets, that’s nearly impossible.
The beauty of this trade is that it simply doesn’t matter how right or wrong things go for shareholders. Just as long as there’s price movement, which is almost assured at this point.
To find the points at which this trade enters profit territory, simply take the cost and apply it to the strike prices.
For instance, if shares rally, they’d have to pass $145.11 ($140 + $5.11) to create a profit. If shares fall, they’d have to drop below $129.89 ($135 – $5.11 = $129.89).
In other words, from its current price of about $137.50, shares would have to move by about 5.5% in either direction for the trader to break even. That’s not a whole lot of movement.
Considering that just this year, shares are up by 37%, that 5.5% price action in a period that contains all of these catalysts is nothing for this giant of a company.