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April 23, 2013, 1:51 p.m. EDT

How to use Microsoft as a CD

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About Andrew Giovinazzi

Andrew Giovinazzi was a member of both the Pacific Exchange and the Chicago Board Options Exchange where he made markets in both equity and index option classes. During that period he never had a down year. In 1991, Andrew started and ran the Designated Primary Market Maker post for Group One, ltd in Chicago. In 2001, he co-founded Henry Capital Management. He became Chief Options Strategist and Option Pit Mentoring in the Fall of 2011. Andrew has a Bachelor's degree from the University of California, Santa Cruz in Economics. /conga/trading-deck/bios/giovinazzi_andrew.html 230100
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By Andrew Giovinazzi

The financial markets are usually the repository of unintended consequences. Here’s an idea outlining how one might take advantage of that, in this case, the effects that the Bank of Japan and Fed actions have had on yields.

The crisis of 2008 was really just a result of too much credit to folks and institutions that could not pay it back. The securities behind that credit were leveraged (bought on credit) and then leveraged again through CDS insurance. As long as the assets (houses) underlying the financial products increased in value it all went great.

When home prices collapsed the financial products snowballed in the opposite direction, causing liquidation at multiple steps along the way. The Fed stepped in with liquidity and congress/president with TARP. This fixed the liquidity problem, since no one would price or accept an asset value anymore. For now, we have the Fed buying bonds and messing with the price signals. We have no idea how that will come out, but money is looking for higher-yielding assets today.

This leads to a potential trade and a possible trading plan moving forward. Find companies that provide a yield, but have the relative safety of a CD. Now you will say the principle is not guaranteed and you are right. Some risks are worth taking if the price is nice and an investor can live with the outcome. Recently, Microsoft /zigman2/quotes/207732364/composite MSFT +0.14%  announced earnings, and by my calculation, earnings grew around 5% year-over-year counting this current cycle. It is not crazy growth, but I am not looking for crazy growth. I am looking for steady, and MSFT is steady for this trade idea.

The name has been on a run recently, a run for MSFT anyway. Part of the Bank of Japan easing and the Fed’s third round of quantitative easing is that money is looking for yield. That was definitely the intended consequence of the actions.

Now a stock like MSFT yielding 2.8% (at current prices) is starting to look pretty good. And that would be the bad part, since my idea in this example is selling an out-of-the-money (OTM) put spread in the name. The recent announcement by ValueAct Capital Management goosed up the stock and the volatility with it. Most of the time Microsoft volatility is so low (around 17%) there is no real money to be made selling options. With the big move, MSFT is in the rare position of having a higher value for its option premium (around 20%).

The idea for this example is to sell the MSFT Jun 27/29 put spread for .25 or better. The worst case is you have to take MSFT down at the 28.75 level and live on the yield. To be prudent, work into the short put spread by one-third at a time with .25 the minimum you are willing to take. On the $2 vertical spread, that is a better than a 10% return on the risk for the trade.

With any put sale, if the investor is willing to take the stock the "out" is not a concern. Using the put spread is a risk-control method for "unintended consequences" whatever those might be.

Disclosure: Giovinazzi has a position in Microsoft.

US : U.S.: Nasdaq
$ 337.11
+0.48 +0.14%
Volume: 6.19M
Nov. 30, 2021 10:32a
P/E Ratio
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