Monday, September 8, 2014

MSFT: Bull play on an old player

Update 10/13/2014: The stock continued to decline and broke below its 20-day price channel on Oct. 10, confirming the signal the next trading day, Oct. 13. I've removed MSFT from the Roll Shelf and calculated results.

MSFT shares lost 1.3% over the 27-day lifespan of the position, or -17.1% annualized. My options spreads produced a 20% loss on debt, or -270.4% annualized.

Update 10/6/2014: MSFT declined below its stop/loss point and I've exited my bull position and moved the symbol to the Roll Shelf. I'll put off calculating profit or loss until the entire trading series for MSFT is complete.

MSFT peaked at $47.57 a couple of weeks after I opened the position., and it appears to be in a genuine counter-trend correction.

Update 9/9/2014: MSFT gained on the day of Apple's iPhone6/Apple Pay/Apple Watch announcement, and I've entered a bull position, structuring it as a bull call vertical options spread, long the $46 calls and short the $48 calls bought with a debit and expiring in Dec. 19.

Although MSFT's price fell during the two-hour-long Apple event, it halted its decline above the day's open, which is more than I can say for AAPL, which is below its opening price as I write this, 12 minutes before the closing bell.

Microsoft Corp. (MSFT) is in the midst of a long running rise. Yet despite the market glitter, it is a one-time giant beset by Lilliputians who have themselves grown gargantuan with success.

The next challenge comes this week when chief rival Apple makes its next strategic move with the iPhone 6 and, rumor has it, a new category, the iWatch, adding an element of news risk to any play.

(The Apple news conference starts Tuesday at 1 p.m. New York time.)

The Chart

The Elliott wave framing places MSFT within a series of 3rd waves of increasing degree, the greatest having begun in July 2010 within the rise from the Great Recession from March 2009.

Click on chart to enlarge.
MSFT 6 years monthly bars (left), 14 months daily bars (center), 30 days hourly bars (right)
A 3rd wave is the middle wave of a five leg trend, either rising or declining. MSFT is in a rising trend. I like to trade 3rd waves. That placement means that a correction doesn't mean the end of the trend. I have the option of riding out the correction in order to profit down the line.

The smallest of the 3rd waves, which I've labeled wave 3 (the base degree), began Jan. 14, 2014 from $34.63. It is presently in its final leg up, wave 5 {-1}. When wave 3 is complete, MSFT can be expected to take back a portion of the rise before resuming its rise to new heights.

Wave 5 {-1} in turn is in its middle wave, 3 {-2}, which means that upside potential remains for Microsoft.

Odds and Yields

Microsoft has completed three bull signals since wave 3 {+1} began in September 2013. All were winners, on average yielding 5.6% each over 53 days.

Two of them occurred this year, in wave 3, which began Jan. 14.

The Company

Microsoft, along with its competitor Apple, is a story stock. Both are far past their prime as brash young starts up set on revolutionizing the world.

Yet Apple, when creakiness set in, managed to reform itself and today, in the new world of smartphones and tablets, is again following a brash tech innovator storyline. Microsoft is still trying to sort out the plot.

Even so, Microsoft, headquartered in Redmond, Washington,  is one of the largest software companies in the world, whose operating system powers most computer throughout the world and whose office software is a mainstay of global business. It has recently moved big time into handheld and cloud computing.

It is big, it is rich, it is tough, and it is home to a lot of talented people. I wouldn't want to count the old guy out just yet.

Analysts are quite negative about Microsoft's prospects, collectively coming down with a 39% negative enthusiasm rating. Zacks Investment Research has ranked assigned a neutral rating.

Microsoft reports return on equity of 26%, with debt amounting to 23% of equity.

Earnings tend to peak in the final quarter of the year, which includes the winter holidays shopping season. That quarter in 2013 came in higher than its year-ago counterpart, which in turn was down slightly from a year earlier. There is no trend.

There have been three earnings surprises in the past three years, including the most recently quarter.

The earnings yield is 5.75%, compared to 2.46% on the 10-year U.S. Treasury notes. The company pays a dividend yielding 2.41% annualized at today's prices.

Growth estimates, combined with the dividend, imply a "fair" price of $31.12 per share, suggesting that the stock is overpriced by 49.6%. I've marked that price level in purple on the center chart.

The stock is selling at 18 times earnings and is also priced at a high premium to sales. It takes $4.36 in shares to control a dollar in sales.

Institutions own 69% of shares.

Microsoft next publishes earnings on Oct. 22. The stock goes ex-dividend in November for a quarterly payout of 28 cents per share.

Liquidity and Volatility

MSFT on average trades 24.4 million shares per day and supports an awesome range of option strike prices spaced 50 cents apart near the money.

The front-month at-the-money bid/ask spread on calls is 1.8%, comparable to 1.7% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Open interest runs from three to five figures, making MSFT one of the most liquid option plays on the market.

Implied volatility stands at 19%, compared to 13% for the S&P 500 index, and has been rising since mid-August after a steep fall.

MSFT's volatility stands at the 21st percentile of its one-year range, giving greater odds of success to positions structured as vertical option spreads bought with a debit and expiring in December.

Options are pricing in confidence that 68.2% of trades will fall between $43.92 and $48.98 over the next month, for a potential gain or loss of 5.4%, and between $45.24 and $47.66 over the next week. I've marked the one-month range on the middle chart in blue.

Contracts today are trading actively with a skew toward calls, which are running 3-1/2 times their five-day average volume. Puts are running at nearly double their average volume.

Decision for My Account

I like the chart and the fundamentals, and intend to open a bull position in MSFT. I shall wait until after the iPhone announcement on Tuesday before making the trade. If MSFT moves adversely after the announcement, then I shall add it to my Watchlist and wait for the right moment to enter a position.

-- Tim Bovee, Portland, Oregon, Sept. 8, 2014


My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

Creative Commons License

All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at

No comments:

Post a Comment