Options Update: Heavy Option Activity Precedes Microsoft’s Earnings

• July 17, 2008
• Mark Fightmaster

Soap Opera

Will he? Won’t he? And I’m not talking about Brett Favre retiring or returning to the Packers, I’m talking about Yahoo!
and Microsoft
. We could go into the latest developments and details in the MicroHoo debacle/courtship, but we have looked at it on our site. Here is my colleague Joseph Hargett’s latest look at MSFT/YHOO. Today, I’m going to look at MSFT for another reason … earnings.

Yesterday’s Options Update subject, eBay was chosen for heavy activity ahead of its earnings report (to see my thoughts, click here) – such is the case today. The sultan of software is set to step into the earnings window this afternoon, with expectations pegged at 47 cents per share. The stock is slightly higher as the noon hour rolls, but the options pits are abuzz with MSFT, which is what caught my eye today.

According to today’s Intraday Volume Explosion List, MSFT has seen heavy activity on both the call and put sides of the options arena. Total put activity has nearly quadrupled the daily average, with 55,379 contracts trading thus far. A majority of this activity was centered on the July 27.50 put (MSQ SY). A block of 2,000 contracts crossed the tape at 11:31 am Eastern, between the bid and ask prices. The transaction was marked “spread,” meaning there could be a corresponding transaction out there somewhere.

This assertion brings us to the call action. The bullish activity has increased threefold above the daily average, with 73,440 total calls crossing the tape. The August 30 call (MSQ HF) saw the heaviest volume, which was eerily close to that of MSQ SY. In fact, the largest block of calls traded mirrored the put block – exactly the same time and size. Unfortunately, it crossed between the bid and the ask as well, so it is difficult to determine the nature of the transaction. It is safe to surmise that the activity is linked.

Sentiment is Anything but Soft

Sentiment from the analyst community is rather one-sided. According to Zacks, MSFT receives 10 “strong buy” rankings, 3 “buys,” and 6 “holds.” The problem with this sentiment is that there is quite a bit of downside potential. Expectations are running high heading into this afternoon’s report … at least from analysts.

Option players aren’t quite as vociferous in their love of MSFT. The firm’s Schaeffer’s put/call open interest ratio (SOIR) of 0.64 ranks in the 56th percentile. This reading is neither bullish nor bearish, but it does indicate that there is room for unwinding of sentiment, the question is: which direction? Depends on the earnings results.

Soft Performance

I may have used this description before; but if you were to saunter over to that big book on your bookshelf that says Dictionary on the side and leafed through for a definition of range bound, you would find 4 letters: MSFT. Since the turn of the century, MSFT has bounced between the 25 and 30 levels. On rare occasions, the 20 level has acted as the lower rail and the 35 level has provided resistance. Those times have definitely been few and far between.

So, what about the potential of the stock topping the 30 level before August expiration? There is a chance, but it isn’t great. I know that I wouldn’t bet a lot of money on the prospects. As for the drop below 27.50 by tomorrow’s close? Again, there is a chance, but I am not certain it will happen. The one certainty is that the reaction to today’s earnings announcement holds a much better chance of being negative.

The Verdict? Yes, earnings open the door for a fast aggressive move in the right direction, but will it be enough to topple either end of this Dow component’s trading range? The numbers will be scrutinized, the results will be analyzed, and MSFT will more than likely stay in its trading range. Remember, an object at rest will likely stay at rest, unless the earnings results are earth shaking. That said, there is far more potential energy for a downward move following the earnings than an upward move.

If you have any questions or comments, make sure to email me. I will do my best to answer your question or address your concern.

Want more of my thoughts on the market? Don’t like my views and want to see those of my colleagues Andrea, Elizabeth, Jocelynn, Colleen, or Joe? Make sure to check out our Schaeffer’s Daily Market Blog section throughout the trading day.

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