Microsoft Corporation (MSFT) investors have expressed optimism, bidding up the share prices of the company ahead of its fiscal second quarter earnings announcement. Analysts' expectations call for earnings per share (EPS) of $1.90 and revenues of $44.1 billion, or growth of 15.9% from last year’s numbers. At first look, it appears that option traders are expecting a move higher, as the number of call options outweigh the number of put options in the open interest. The unusual option trading may create a strong downward trend in the price action if the tech giant delivers a negative earnings surprise.

A growing collection of call options remains in the open interest for MSFT, and option premiums are unusually elevated right now. The trading volumes indicate that traders have been selling puts and buying calls in anticipation of an favorable earnings report. Unwinding these bets could result in unexpected downward pressure on the share price of MSFT.

Accurately predicting the direction a stock will move after earnings is difficult. However, a comparison between the stock's price action and option trading activity shows that, if Microsoft delivers a positive report, the company's share price could rise significantly, potentially moving it above the recent all-time high in the days after the announcement. This is possible because options are priced for a small upwards move, but unexpected poor news could catch traders off guard and create a rapid decline in share price.

Key Takeaways

  • Investors and traders have bid up the share price to an extreme range headed into the earnings announcement.
  • The share price has been closing well above its 20-day moving average and is not too far off from it's all-time high.
  • Call and put pricing is predicting a stronger move upwards.
  • The volatility-based support and resistance levels allow for a larger move to the downside.
  • This setup creates an opportunity for traders to profit from unexpected earnings results.

Option trading represents the activities of investors who wish to protect their positions, or speculators attempting to profit from correctly forecasting unforeseen moves in an underlying stock or index. This makes option trading a literal bet on market probabilities. By comparing the details of both stock price and option behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below illustrates the share price action for MSFT as of Monday morning. This created the setup leading into the earnings report.

Earnings pricing for Microsoft Corporation (MSFT)

Current Trends

The one-month trend of MSFT stock has the shares rising to an extreme range. It is notable that, over this time period, the highest MSFT share price was nearly $290 in mid-July, while the lowest share price was roughly $262 in late June. The price closed in the upper region depicted by the technical studies on this chart.

The studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has moved to a higher range all month. This price move from MSFT shares implies that investors are expecting a positive earnings result.

Tip

The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.

In this context where the price trend for MSFT has been rising to an extreme range, chart watchers can recognize that traders and investors are expressing optimism going into earnings. In the week before earnings, Microsoft's share price reached its all time high, before slightly pulling back the following Monday and establishing a new all time high. That makes it important for chart watchers to determine whether the move is reflecting investors’ expectations for a favorable earnings or not.

Option trading details can provide additional context to assist chart watchers in forming an opinion about investor expectations. Recently, option traders are favoring calls over puts by a slim margin, as the open interest on options has a greater number of calls than puts. A higher number of calls than puts generally expresses optimism, and traders appear to be expecting MSFT to move higher after earnings.

Tip

The Keltner Channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Because the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting a multiple of ATR from the average price, then this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that MSFT shares are in an extreme range and have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and July 30, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 32% that Microsoft shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 34% probability if prices go lower on the announcement.

It's important to note that the open interest featured over 1.2 million active call options compared to roughly 1.1 million put options, demonstrating the bias that option buyers had, as just over half of the trades were call options. This amount normally implies that call option traders expect a jump in price. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options traded has only mildly skewed expectations higher. A far more complacent outlook is implied.

Option Pricing for Microsoft Corporation (MSFT)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at four times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months.

The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such a close range with plenty of space to run downwards compared to upwards. This suggests that option buyers don't have a strong conviction about how the company will report, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising report would push prices dramatically higher or lower.

Volatility pattern for Microsoft Corporation (MSFT)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, MSFT shares fell by 2.8% in the day following and continued to fall the following week, settling below the 20-day moving average for several weeks. Investors may not be expecting the same kind of move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

Microsoft earnings can have a significant impact on index prices and the market as a whole. This is because MSFT is one of the heaviest weighted stocks in many exchange-traded funds (ETFs), such as State Street's Technology Sector Index ETF (XLK) and State Street's S&P 500 Index ETF (SPY).

No matter what the report says, it will likely have a significant impact on stocks in the technology sector. A positive report could lift other stocks in the sector such as Amazon.com, Inc. (AMZN), Google parent Alphabet Inc. (GOOG), or Apple Inc. (AAPL).

Wrapping Up

Traders and investors have bid up the share prices of MSFT ahead of its earnings report. The share price is in an extreme range based on volatility-based support and resistance levels. With a higher number of calls than puts in the open interest, MSFT's share price could face downward pressure from an unfavorable earnings announcement. Microsoft's earnings announcement is significant because of the potential impact on the rest of the market.