Trading Microsoft ahead of earnings

Microsoft (NASDAQ: MSFT) is set to report earnings for their fiscal second quarter of 2010, tomorrow, after the market close.

Expectations are high for MSFT, especially given the release of Windows 7 and what looks like strong holiday sales and high consumer demand for that product.   There has also been an increase in Bing usage. MSFT is heading into this report under expectations that it will announce quarterly results that exceed Wall Street’s consensus expectations.

Both IBM (NYSE: IBM) and Intel (NASDAQ: INTC) have had strong quarters, but MSFT does find itself in a unique situation. One of the wild cards in this situation is Apple (NASDAQ: AAPL), which today is expected to release its new tablet computer. The “iPad” may not only take more market share away from the PC market, but potentially the XBOX 360, both of which may hurt Microsoft.  The AAPL tablet will have accelerometers similar to the iPhone and iPod, which may add a new competitor in the gaming space offering a unique tactile and visual experience.

Regardless of those issues, tomorrow’s earning report should be a positive one for the stock, although the market’s expectations are high as of late.  Using both Google (NASDAQ: GOOG) and AAPL as examples, both reported strong quarters and the response to both of these names, among others, was relatively poor.

This may be partially attributed to market participants rotating out of the high-beta tech trades and into lower-beta, more stable stocks. MSFT does has an advantage in that it is NOT typically a volatile stock and has behaved like more like a mature conglomerate as opposed to a tech stock.   As you will note below, MSFT has been moving on less than 17% 30-day volatility for the past several months. There is quite a differential between the implied volatility and the historic, with IV at a 62% premium to 30-day historical vol. This would incline me to be a seller of volatility as I believe that MSFT will have a relatively muted earnings report. MSFT is typically NOT a big mover over earnings as well, with the average move being less than 4% the day of its earnings report.  It does, however, tend to move a bit more (>5%) the day after.

There are 29 analysts covering MSFT.  The consensus estimate is $0.59, and the high and low estimates are $0.66 and $0.45, respectively.  Revenue estimates are sitting around $17.8 billion.   These estimates would be  a considerable increase from a year ago, when the company brought in earnings per share of $0.47.

Of the analysts that cover MSFT, 59% of them list MSFT as a “strong buy.”   Microsoft’s outlook appears stronger than it has in some time and consumer spending on technology and electronics is returning but is still far from 2007 levels.

If I were to have a bias with MSFT, it would be to the upside.  MSFT is up 98% from its 52-week low back in March, 2009, but is off 16% from its week-ago high.  The 29 mark  seems to be a moderate support point in recent trading and is a level at which I would feel comfortable owning MSFT.  The broad market is a bit shaky here and we do have a busy week ahead as well as the President’s State of the Union address tonight.   I do NOT, however, see MSFT below $26 in the next month or so.

With all that said, I thought I would mix it up a bit and use an uncommon options strategy to trade MSFT.   I am examining a 28/27 March Put Ratio Spread for a 0.25 credit.  This meets my short Vega desire, takes a moderately bullish stance on MSFT, and utilizes my absolute support level of $26.00 in MSFT.  If MSFT drops to $27.00 or more importantly finishes there on March expiration, I stand to make my max profit of about $125 per spread.  Synthetically, this is like selling the March 26 put for $0.25, but allows an extra profit between 26 and 28.  Happy trading…

For more on MSFT:

Cramer and Microsoft (MSFT) Option Plays

Long-term call selling in Microsoft (MSFT)