As my colleague and esteemed financial reporter Chris Preston, reported earlier today, “Microsoft has been one of the strongest performers in the technology sector in 2012. Entering the day, the tech stock had climbed 16% year-to-date. News of its new e-tablet has given the shares another 3% boost in early Tuesday trading”.
Trading was active as a result of the encouraging news, with 59 million Microsoft shares and 287,000 MSFT options changing hands throughout the trading day. Options order flow on the tech bellwether was almost 3X the daily average.
The largest options trades in Microsoft on Tuesday was part of a spread, in which an investor sold 15,000 Jul12 31 calls on MSFT at $0.81 to buy 15,000 Jan13 30 calls for $2.62.
The investor/trader is taking a position in 25,000 Jan13 30 calls and paying $2.62 in premium or $6.55 million to lock in the right to buy (or call) 2.5 million shares for $30 through January 19, 2013. They are helping to finance the calls by writing (selling) 25,000 Jul12 31 calls that are currently $0.25 out-of-the-money and collecting $0.81 per contract or $2 million. By doing this the investor is basically willing to be sellers of the stock at $31.
The most profitable scenario from the spread happens if MSFT settles at $31 at the July expiration (31 days). At that point, the 31 calls, which were sold, expire worthless and the investor can either hold the Jan12 30s or exit the trade entirely.
The risk to the MSFT Jul12 31/ Jan13 30 call spread is from a significant push higher or lower in the tech giant. If Microsoft falls, both contracts lose value and the entire debit can be lost if the position is left open and MSFT settles below $30 at the January expiration. If there is a substantial move to the upside, then assignment on the July 31 calls comes into play.
By initiating the Jul12 31/Jan13 30 call spread the investor is making the assumption that the price of Microsoft will continue to move higher throughout the second half of 2012, but the stock might take a short-term reprieve from its bullish ways between now and July options expiration in 31 days.
Taking advantage of range-bound price action is a legitimate way to make gains, particularly during stagnant times in the market. Earlier today I talked about another way to take advantage of the range-bound price action in Apple. Check it out.
If you have any questions about the intricacies of range-bound strategies as a way to trade/invest please feel free to email me at [email protected], and don’t forget to follow me on Twitter at @OptAdvantage.
Editor and Chief Options Strategist