Options Update: Microsoft Attracts Heavy Put Volume Ahead of Earnings

After the market closes on Thursday, Jan. 22, Microsoft
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is scheduled to slip into the earnings confessional to release its fiscal second-quarter performance.

Currently, analysts are expecting the world’s leading software developer to report a profit of 49 cents per share, a penny shy of last year’s results. Historically, MSFT has bested Wall Street’s views in 3 of the prior 4 reporting periods, with an average upside surprise of 3.88%.

Heading into the report, options traders have piled into put positions, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.79 ranks above 89% of all those taken during the past year. What’s more, the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) 10-day put/call ratio is higher than 80% of all those taken during the prior 52 weeks, underscoring this preference for bearish bets.

This speculation has extended into today’s trading, as put volume has more than doubled MSFT’s daily average. What’s more, this spike in volume has placed the shares on our Intraday Volume Explosion List. Amid the more than 34,000 puts changing hands on MSFT today, some 20,000 have traded at the stock’s out-of-the-money February 18 strike, drawing my attention this afternoon.

Microsoft option volume details

The Anatomy of a Microsoft Put Position

This trend toward MSFT put options has taken a twist in today’s trading. Looking at the chart above, you can see that the vast majority of today’s volume has traded at the bid, suggesting that traders are selling puts. Running with this theme, I noticed that a block of 2,336 contracts changed hands at 10:44 a.m. Eastern time at the bid price of $0.80, suggesting that the options were potentially sold to open. The total credit received for this trade arrives at $186,880 — ($0.80 * 100)*2,336 = $186,880. Remember that a put-sell trader keeps the premium received on the trade as long as the underlying shares remain above the sold strike through expiration, which, in this case, is Feb. 20, 2009.

By entering this trade, the investor is indicating that he expects MSFT to hold steady despite the company’s looming earnings report later this week. With the selloff in the broad market holding sway today, MSFT is off nearly 5% at last check, pushing the shares closer to breaching key technical support. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

Technically speaking, MSFT has lost more than 40% during the past 52 weeks, outpacing the tech-laden Nasdaq Composite’s (COMP) decline of 34% for the same time frame. What’s more, the equity remains locked in battle with resistance at its falling 10-week and 20-week moving averages. Since December, MSFT has finished the week above these intermediate-term trendlines on only 3 occasions. Currently, the security is being pinched between its 10-week moving average and support at the 18.50 region. This area has held as support for MSFT since mid-November 2008, and offers some ballast for a sold February 18 put position. However, a breach of this area following a poorly received quarterly report could point toward an extension of MSFT’s long-term decline.

Weekly chart of Microsoft since December 2007 with 10-week and 20-week moving averages

The Sentiment Drivers

Despite the burgeoning pessimism among options traders, Wall Street analysts are excessively bullish on MSFT. Currently, 15 of the 19 analysts following the shares rate them a “buy” or better, with no “sell” ratings to be found, according to Zacks. Additionally, Thomson Financial reports that the average 12-month price target for MSFT rests at $27.53 per share – a 39% premium to the stock’s Friday close at $19.71 per share. A lackluster earnings report or poor fiscal guidance could prompt downgrades or price-target cuts from this bullish bunch.

Sentiment indicators for Microsoft

The Verdict?

Trading options ahead of an earnings report is risky business, and MSFT is no exception. Judging by the groundswell of put open interest heading into the report, investor expectations could rest below Wall Street’s view for second-quarter earnings of 49 cents per share. However, more emphasis should be placed on MSFT’s forward looking statements. Clearly, today’s put sellers are not expecting anything out of the ordinary on this front. Personally, given the information above, I would avoid making any sizable bets on the shares until after MSFT releases its report.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.