Tuesday, April 10, 2012

Microsoft Cashing In On Another Mobile Phone Giant

For as long as I have been trading I have always viewed Microsoft (MSFT) as more of a fixed income investment that moves up and down between $24 - $29/share each year, pays a respectable dividend and has solid financials. Microsoft is involved in a lot of different spaces ranging from their most commonly known Windows operating system, web browser, Bing search engine, Xbox gaming, and of course all of their Microsoft software products. Up until recently all of Microsoft's attempts at getting into the mobile phone space have proven to be somewhat unsuccessful.

Last week, Microsoft and Nokia (NOK) announced a joint smartphone venture that went on sale this past weekend. This new smartphone will be able to run on AT&T's (T) 4G LTE network, as well it is set to sell for half the price of Apple's (AAPL) iPhone and Google's (GOOG) Android phones. This smartphone will be made by Nokia and powered by Microsoft's Windows platform. Microsoft's new smartphone has the potential to be a real game change in the sector and could steal some serious market share away from industry leaders Apple and Google.

That being said Microsoft has had some real flops in recent years. The company sunk billions into their Xbox franchise that went unprofitable for several years and they continue to lose money on their new search engine Bing. Not to mention Microsoft's last attempt at entering the smartphone space went unnoticed and was forgotten almost as fast as it showed up to the party.

I think that this time is different. This phone for starters is built by Nokia, who took the time to build a smartphone that is both crack and scratch resilient. The phone is comprised of a polycarbonate shell that gives the phone a sense of real durability. In the smartphone space durability is something that is seriously lacking, hence the huge market for smartphone cases and covers. The phone also sports a large screen that is designed to perform just as well outdoors as it does indoors. Lastly, the most important component of this new smartphone is that it is set to sell for half of what iPhone and Android are currently selling for.

Another component that makes Microsoft's smartphone appealing is that the device is set to run on Windows 8 which is set to launch later this year. The combination of this new smartphone and Windows 8 should help justify a continued appreciation of Microsoft's stock. Microsoft has already broke through the $30/share mark, which has not happened since the end of 2008/beginning of 2009.

That being said I still feel there is continued upside left in this stock that can be realized. With the amount of revenue that Microsoft should be able generate off this new smartphone in conjunction with the launch of Windows 8 and the overall hype that the market is already giving it, I would not be surprised to see Microsoft get close to their 2007 highs of $36 - $37/share.

That being the case I think there is an opportunity to use the options currently trading on this stock to capitalize on this anticipated upward movement as well as limiting the overall investment in the stock itself. Knowing that this phone just came on the market and Windows 8 does not come out until later in the year, I think it is safe to say that a little run time is needed to let these factors play out and for the stock to increase in value. In a situation like this I like to buy out-of-the-money calls at a strike price that I find to be favorable and in a contract month that gives me enough time to see if my idea actually plays out prior to my options totally depreciating in value.

In the Microsoft situation I would suggest taking a look at the January 2013 options, specifically the $35 calls that at the time of this article were trading for $1.06/share. Since that essentially is $106 for every call contract that is purchased, I find that to be a bit expense since $35/share may never come between now and January 2013. To help decrease the cost of this trade I would also suggest selling a (naked or cash secured) January 2013 put at the $28 strike. This put option is currently trading for $1.43/share, or $143/contract. Doing this trade would credit the trader $40 per spread.

I like the $28 strike because historically that seems to be the top end of Microsoft's previous range (resistance level), which is now the new support price. I also like the $28 strike because simply it is cheaper than the current $31.50/share that Microsoft is trading for and when looking at the financials of Microsoft it is an excellent entry point for this stock. That is of course assuming that the trader had the cash to actually buy the stock at that price.

This trade is a bit of a longer term trade but considering the situation that I described above I feel that it is the trade that makes the most sense given the amount of time it is going to take for some of these items to play out. In any case depending on your broker the average margin required to do this trade is between $370 - $400 per spread, if you factor in the $40/spread that is received for doing the trade that is a 10% - 11% return on your money for just sitting and waiting.

This trade has three possible outcomes, all of which I find favorable.

  • The stock continues to move higher and approaches the $36 - $37 range, the call option becomes worth more (unlimited upside) while your put options continues to lose value and can be bought back for cheaper than it was originally sold for.
  • The stock repeats history and stays range bound between now and January 2013. Your call and put option(s) will expire worthless and you keep the $40/spread for doing the trade.
  • The stock sells off and goes back below $28/share between now and January 2013. Your call option expires worthless and you are put to Microsoft stock at the price of $28/share as well as you get to keep the $40/spread for doing the trade, which will help offset the share cost, slightly.

Microsoft overall is extremely cheap from a valuation standpoint and stands to gain some serous market share if this new smartphone ends up being as big as anticipated. In my opinion anyway you look at it this trade is a win-win, no matter what the stock does between now and January 2013.

Disclosure: I am long T, AAPL.

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