Microsoft (MSFT) looks good for a trade. But, we’re not ready to marry it yet.
In last Friday’s Market Minute video (which was recorded last Wednesday evening, before Thursday’s big decline in the stock), I argued for selling uncovered put options on MSFT if/when the stock got close to support near $390 per share.
Traders who took advantage of that idea could have sold the February 13 $390 puts for about $4.00 on Friday morning.
If you did this, then you got paid $400 up front for promising to buy 100 shares of MSFT at $390 per share if it closes below that level this coming Friday. It’s a trade that will be profitable as long as MSFT does not fall below $386 (the $390 strike price of the option minus the $4 premium received).
So far, with MSFT trading at $404 on Monday morning (as I’m writing this), it looks like a good trade.
Some readers have questioned, though, “Why wouldn’t you just buy call options when the stock gets close to $390?”
It’s a matter of confidence. Specifically, how confident I am that MSFT has put in a bottom and is ready to start a new, intermediate-term rally phase.
Let me explain…
By selling uncovered put options on MSFT, I’m getting paid merely to agree to buy the stock at a price I’m willing to pay anyway. If MSFT bounces right away, I’ll profit as the option decays and eventually expires worthless. And, if the stock falls, then I’ll buy it at a price I wanted to pay anyway – and I keep the $400 premium.
It’s important to understand that by selling uncovered puts, I don’t need MSFT to rally in order to make money. I just need it not to fall too much.
If I buy calls, however, then the only way to profit is if MSFT rallies. And, it has to rally enough to recoup the inflated call option premium. So, I have to be confident that’s going to happen.
For example, on Friday morning, with MSFT trading near $394, the MSFT March 20 $400 calls were trading for $14. If I bought this option, I’d need to be confident MSFT would trade above $414 (the strike price plus the call option premium) by March 20. Based on the technical setup, I wasn’t convinced that could happen.
Here’s the chart…
Notice that as MSFT declined toward $390 on Thursday, all of the momentum indicators at the bottom of the chart dropped to lower lows as well. This indicates the momentum behind the downtrend is still strong. So, the trend is likely to continue.
Yes, MSFT was oversold enough – trading well below all its various moving averages – to justify a bounce off the support level (near $390). But, given the confirming action in the momentum indicators, any bounce is likely to be short-term only. There’s a good chance that once this bounce runs its course, MSFT will come back down and make a slightly lower low. If the momentum indicators can then make higher lows, then we’ll have the sort of “positive divergence” that often signals an intermediate-term bottom is in place.
So, I’m willing to bet on a short-term bounce. But I’m not yet betting on an intermediate-term rally.
A quick bounce will generate a profit on short-term uncovered puts.
In order to buy call options, though, I prefer to see a more confident setup for an intermediate-term rally phase.
Best regards and good trading,
Jeff Clark
Editor, Market Minute
P.S. If you like this series… let me know at [email protected].