Taking profits in Microsoft (NASDAQ: MSFT)

On Wednesday, I suggested a unique way that traders could take a bearish volatility bet while maintaining a slightly neutral, but moderately bullish view on Microsoft (NASDAQ: MSFT).  In this article, I detailed the specifics of the trade, including profit and loss possibilities.

The trade was an out-of-the-money ratio put spread, which involved the purchase of one 28-strike put and the sale of two 27-strike puts for a credit of $0.27 (that was the fill I received) .  The trade has a relatively high probability of success with a breakeven down at $25.73. As long as the stock stays above that level, the trade will be profitable.  If MSFT were to continue to rally, the 27-cent premium would be held as profit as both puts would expire worthless.

MSFT announced a record second quarter, with revenue of $19.02 billion, a 14% increase from the same period in the prior year.  This is huge for MSFT from a growth perspective. Operating income came in at $8.51 billion, net income at $6.66 billion, and earnings per share at $0.74, which represented increases of 43%, 60%, and 57%, respectively, compared to the same period one year ago.  Those numbers included the recognition of $1.71 billion in deferred revenue.  If you back that out, earnings per share come in at $0.60 per share. Windows 7 certainly helped the cause.  Out of the 29 analysts covering MSFT, earnings were 25.42% greater than the consensus estimate of $0.59.

The bottom line is that even with the fantastic report, MSFT shares are off 2.5%, or $0.73, to $28.43.  Typical for the current market climate.  More important was the move after the report, which is what I expected – muted – although I thought it would at least hold its ground and move slightly higher.

I put a support level on the stock and for me, personally, I would be okay maintaining this position, simply because it actually will get more profitable if MSFT SLOWLY goes down to $27.00 (slowly being the operative word here).  The position will also benefit from the passage of time, being that the theta is positive.

So why did I title this article ‘taking profits in MSFT’ if I am okay with holding onto it?  Well, remember I am not here to manage your accounts.  That would be impossible and certainly absurd, because I have no idea what YOUR sentiment, risk tolerance, or personality is.  The point is this; whenever you read an article from me or from one of my colleagues (or from any investment professional), be sure their thesis not only falls in line with yours, but that you have a goal or target in mind when placing the trade as well as an acceptable stop for the trade as well.  Lastly, be sure you are confident in the behavioral characteristics of that strategy in the open marketplace, as some options strategies can have certain”gotchas” with respect to Theta and Vega especially.

As for the MSFT spread, one could close the trade for a small profit today, which would be only about 1% of the margin required to put it on. But if your sentiment has changed for MSFT, don’t ever be afraid to take risk off the table, especially if you can do it for a profit   Should you want to build your own profit/loss chart for a visual representation of this trade, consider signing up for a free virtual trading account at OptionsHouse.

Have a fantastic weekend and stay tuned Monday and all through next week as we offer more strategies to trade this market and earnings, while minimizing risk.