Here is how we traded Microsoft ($MSFT) – July 25, 2023
Dan Fitzpatrick at StockMarketMentor.com. I want to show you something that we did at Option Market Mentor today, a couple of hours before the market closed.
As you should know, anyway, Microsoft ( NASDAQ: MSFT ) reported earnings after the bell. Now, in the Options Market, options traders always game this type of thing. They are deciding how much the stock is going to go up, how much the stock could go down, and stuff like that.
The idea is, that buyers want to buy options that they think are going to make money if the stock moves in their direction. The issue with that is, the stock can move in your direction but if you paid too much for the option then you are still going to lose money. If you paid a little bit for the option, then you can make a lot of money.
In other words, the stock doesn’t just need to move in your direction, but it needs to move enough in your direction to have you make money. And if you are trading short-term options, that can be a little bit of a challenge. In my mind, the vast majority of times, not all the time by any means, the vast majority of times the suckers bet is, to buy calls or puts.
Because they are priced to make you lose money, and this is why, you have to look at the other side of the trade. Sellers are, essentially, like insurance companies. They kind of use the option equivalent of actuarial tables. They look at probabilities and they determine how much the stock is likely to move, based on the pricing in the Options Market.
This is how it works, let’s say Microsoft ( NASDAQ: MSFT ) closed at 350.00. So they think that it is going to trade either $5.00 up or down. That’s the maximum move that they think it is going to trade. So they will sell what is called a straddle, where they will sell a $350.00, that’s at the money, they will sell a $350.00 call and a $350.00 put. And they need to get at least $5.00 for that.
Because if they get less than that, then they are putting themselves at risk. To where, if they only got, say, $4.00 for it, or something, for the combined straddle, call and put. Then what happens if the stock moves up to $350.00? They’re screwed, they are losing money. And so what they will do is, they will look at what the price of the straddle is and then they will “bet” accordingly.
And they may do that by, again, selling an at-the-money straddle. But they also might look at the implied moves and say, Well, I think I am going to trade out of the money. If the implied move is going to be $5.00, one way or another, then I want to go ahead and sell a call option and a put option that is a little bit outside of that $5.00 anticipated range.
Well, that is what we did, I just used $5.00 because it is easy math. That is what we did, I looked at the Options Market and it was actually a pretty easy look. The implied move on these options, right here, these are the front month options, they expire this Friday. The implied move, we’ll call it $20.00.
That is what the Options Market was pricing. The maximum move that they thought the trade could make. And you will notice here; 78 percent implied volatility, these were expensive options, so you want to be selling those. So a $19.00, we will call it a $20.00 implied move. If the market thinks this thing can move up to 370.00 or down to 330.00, as a maximum move, it would close this Friday.
So what did I do? Well, I’ve got a little bit of a “wussy” part of me up above here. And rather than go down to, and again, it was at 350.00, rather than go down and sell the 370.00 calls, I went up further and sold the 375.00s. And then on the downside, I did like that $20.00 difference, so I sold the 332.50 puts.
And so, based on the premium that we got, these are $10.00 spreads on each side, sell the 375.00, buy the 385.00. Sell the 332.00, and buy the 327.50. And so we are taking a $10.00 risk maximum (I hope you can understand this), and we are only getting $250.00. So we are risking 1,000 and we are only taking in $250.00, so our net risk is $750.00. That is not a good risk/reward, not at all. But when you factor in the probabilities, I like it.
And so this is a trade that we took. And now as I am looking at this, we take in $250.00 per contract on this, we are going to make a gang of money here tomorrow. And do you know what we have to do? Nothing really, just hold the position until Friday. Or just hold it throughout the day.
Maybe on Thursday, when the options bleed enough of a value to where they are just about worthless, then you go ahead and spend a couple of bucks in commission and close the trade. So this is the type of earnings trade that I like to make because I’m with the house. I am selling probabilities as opposed to buying probabilities and hoping that they are wrong. So you may want to give that a try.
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