Using Options to Squeeze a 20% Return From Microsoft Shares

Apr.10.11 | About: Microsoft Corporation (MSFT)

Have you ever seen this from your Internet Explorer: "Internet Explorer has stopped working"? Shareholders of Microsoft (NASDAQ:MSFT) must be wondering if Microsoft stock has "stopped working". The stock has gone nowhere while stocks of rivals, such as Apple (OTC:APPL), have still been able to log impressive gains. However, by using options, there is a way to squeeze a 20% return out of Microsoft even if the stock only increases by 5% over the next 10 months.

Stock options open up a number of different trading avenues for you to explore. The strategy that I'm discussing here is relatively easy, will not require much maintenance, and can be accomplished with a low level option clearance from your brokerage account.

One reason that I like this strategy with Microsoft is due to the fact that the liquidity in the Microsoft option market is excellent. The slippage, or price between the bid and the ask, is usually minimal. Also, due to the stock's trading volume it is easy to unwind and close any positions.

Stock, Call, & Put

The strategy involves buying the stock, selling a covered call, and selling a put. Microsoft closed at $26.03 in the afterhours trading session on 4/8/11. I would buy the stock and then sell the Jan 2012 $27.50 Call option. At the same time I would sell the Jan 2012 $26.00 Put option. The premium gained from the Call would be $1.44 and the premium gained from the put would be $2.36 for a total option premium of $3.80. The combined option premium alone represents 14.6% of the current stock price.

The expectation of this trade is that Microsoft trends either flat or rises just over 5% in the next ten months. If the stock closes above $27.50 as of the option expiration date then you will be required to sell your shares at $27.50. This would represent a gain of $1.47 or 5.6% from the sale of your stock. During these ten months you will also be collecting any dividend issued.

Should Microsoft stock decline, the premiums gained just from the call will give you a 5.2% cushion. If Microsoft falls below $26.00 at option expiration then you will need to purchase shares of the stock at the price of $26.00. The premium from selling the put option would place your effective purchase price at $23.64.

If Microsoft stock is above $27.50 at option expiration then you will make $1.47 from the sale of the stock, $1.44 from the Call premium, and $2.36 from the Put premium. The total $ received would be $5.27 which represents a 20.2% gain from the current stock price of $26.03. Click to enlarge:
Click to enlarge

Floors and Ceilings

Microsoft's high of this year was $28.87. Looking back on the stock's price, the $30.00 level offers stiff resistance which is why the covered call of $27.50 was chosen. If exercised your effective sell price would be $28.94.

As for a floor on the stock, the $23 price level appears to offer strong support. If the stock dropped below $26.00 you would still be effectively buying the stock at a price of $23.64. Of course, due to the ease of liquidity for Microsoft options, both sides of the option trade can be closed before expiration.

Below is a look at the price level support and resistance using a chart that includes
the stock price as well as the EPS actual and future estimate for the stock.

Chart Source:

Disclosures: I am long MSFT. I receive no compensation to write about any specific stock, sector, or theme.