Tuesday, July 22, 2014

* Microsoft (MSFT) - Earnings Preview: Risk is Here For Good Reason; MSFT is Back in Play

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MSFT is trading $44.98, up 0.3% with IV30™ down 11.3%. The Symbol Summary is included below.

Provided by Livevol

This is a volatility and stock note wrapped inside an earnings preview for MSFT which has earnings due out after the bell today.

MSFT is a changing entity, a growing entity, an entity which is outperforming the NASDAQ and has its eyes set on several markets and competitors.  All of that means risk, and the option market is quite correctly pricing elevated risk into this earnings report as Microsoft is no longer a sleepy giant, it's a risky entity fighting to grow, and in many ways, succeeding in that fight.

The option market is pricing in a $1.80 move off of earnings.

The one-year stock chart is included below.

Provided by Charles Schwab optionsXpress

We can MSFT is up 40.5% in the last twelve months and is right at a 52 wk high.  But isn't everything up in the technology sector?  Yes, but not as much as MSFT.

Let's turn to a one-year stock chart of MSFT vs NASDAQ vs XLK (Technology ETF)

Provided by Charles Schwab optionsXpress

We can see the returns:
MSFT: + 40%
XLK: + 25%
NASDAQ: + 23%

For the record, AAPL is +54%.

So what's going on with MSFT?  Why is it all of a sudden relevant and why is the stock crushing the indices?  because MSFT is executing, very well.

MSFT has entered several markets where it is not only not the leader, but a significant laggard.  Think search (GOOG vs Bing) and tablets (iPhone/iOs, Android vs Windows).  Then there's the cloud, which is a huge market and MSFT is #2 (to AMZN).

David Pann, general manager for Microsoft’s Search Network, says clicks on Bing ads are up 30% from a year ago, and mobile ad clicks jumped 133%.


Microsoft’s offering still has a tiny market share in search ad revenues, owing to Bing’s merely small market share in search.

Source: Bing Ads Are Growing Nicely, But Microsoft Is Still Living In Google's World written by Robert Hof (7-9-2014).

There are more stats in that article for the curious minded.

Even though Microsoft Surface tablets have not generally sold well, Microsoft has increased its market share from 0.9% in 2012 to 3.4% in 2013.  Microsoft has been spending heavily on Surface tablets advertising.

Looking to 2017, IDC estimates that Microsoft’s share of tablets will rise to 10.2% from present 3.4% while Google Android’s market share will fall to 58.8% from 60.8% in 2013. In 2013, Apple tablet market share has already fallen to 35% compared to 45% in 2012; according to IDC Apple share will fall to 30.6% by 2017.

Source: Microsoft Playing Catch-Up In Tablet World, written by Nigam Arora (12-5-2013)

But here's the catch with Tablets, and it's two-fold.

1. Overall, growth in tablets is seen to slow significantly.
2. MSFT has introduced Surface (re-introduced) with a better battery life, a USB port, that can run Office and has a detachable keyboard.  It's the Office part that is they key; the rest can be replicated rather easily.

Public IT cloud services spending will reach $98 billion in 2016, with a compound annual growth rate (CAGR 2011-2016) five (5) times the growth of the IT industry overall.

Source: IDC Study

As for MSFT:
It's official: Microsoft is now the second-largest cloud services provider after Amazon, pulling away from the chasing pack that included Google, and salesforce.com. In the first quarter of the current fiscal year, Microsoft had a blistering 154% year-over-year growth. The company's cloud services consist of IaaS, PaaS, and its hybrid cloud.

Source: Microsoft Corporation Becomes the Second-Largest Cloud Services Provider, written by Joseph Gacinga

OK, that's a bastardization of some rather complex stuff, but just so it's clear, things are a changing.  The fact that MSFT is a laggard may be a boon considering they have room to grow (that might be backwards logic). All of this means risk, and the option market is pricing risk into earnings.

Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days). So, in English, the red line is a chart of risk.

The blue "E" icons represent earnings releases and I have highlighted them in yellow.  Note that the risk going into this earnings release for MSFT is elevated at a similar level to passed earnings and while that makes perfect sense, it' quite different than many other firms (see AAPL Earnings Preview and NFLX Earnings Preview).

Finally, the Options Tab is included below.

Provided by Livevol

Using the at-the-money (ATM) straddle in the July 25 weekly expiration we can see that the option market reflects a price range of [$43.20, $46.80].

Using the Aug monthly expiration the option market reflects a price range of [$42.70, $47.30].
  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.
This is trade analysis, not a recommendation.

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