Microsoft reports earnings tonight after market close. It is quite remarkable that Microsoft implied volatility in the front month is elevated to highest level in 52 weeks. At-the-money $29 straddle is going for $2.10. This is huge because if you really believe the straddle is cheap, then you expect Microsoft to make a monster 7.2% move in either direction. Given its large market cap and weighting in Nasdaq, you bet a move like that would move the index significantly tomorrow.
Looking at the daily chart you can see, Microsoft did make an almost 10% move to upside on excellent report last time they reported. Last quarter, they beat earnings by nearly 25% (40 cents vs. 32 cents consensus). I expect another monster quarter from Microsoft and beat on both top and bottom line. While I certainly have a bullish bias, the move in the stock might be a bit subdued or muted due to general market sell-off we are currently under.
With that said, I think the straddle is overpriced and I want to be a seller of elevated implied volatility. Specifically, I like the following double diagonal calendar spread:
- Buy to open March $28 calls
- Buy to open March $31 calls
- Sell to open Feb $28 calls
- Sell to open Feb $31 calls
As of this writing, the whole spread is going for a debit of $0.42. Currently, Feb IV is at 35 and March at 29. Tomorrow morning, I expect both Feb and March IVs to collapse and settle around 25, which actually might be conservative considering that the VIX is elevated as general market continues to sell-off.
If you adjust the IV to 25, the hypothetical P&L chart on the trade shows break even points of $27 on the downside and $32 on the upside. I like the odds.
Good luck!
