Microsoft Stock Price – more of the same

I’ve been holding a few April call contracts in Microsoft (symbol: MSFT)since late 2006 and was happy to have ridden a portion of the wave up from the high twenties to nearly $31/share leading up to the consumer launch of Vista.

Unfortunately, my profits have all but evaporated over the last couple weeks after a less than exciting product launch and many less than warm reviews of the product in general.  The buzz just isn’t out there for Vista. Those that have tried it say it has a few nice whiz-bang features, but really nothing to write home about.

Is it too much to ask that after 5 plus years in development, Microsoft add a little flash to their product to really build up some excitement?  Whether the changes are earth shattering or not, consumers just want flash.  They are used to the upgrade process by now, they are used the hardware driver issues by now, they are used to having to install third-party virus scanners and spyware detection software now, give them something new. Give them something that will make all the PC magazines gush over for at least a few months.

The most recent announcement by Ballmer noted that revenue projections for Vista were overly optimistic which, as of this writing, has caused the stock to decline close to 3% today.  Microsoft is still making boatloads of money, but until they do something to cause some excitement and buzz in the industry, I’m afraid their product sales and stock price will languish.

Six months of options trading – a look back

I’ve been investing in the stock market for many years but, for a variety of reasons, I never traded any stock options. I had always had a high level of interest in options as they have limited risk with an extremely high amount of leverage, but I hadn’t gotten around to actually pulling the trigger.

I told myself in July of last year that I would give it a shot. Resigning myself to the fact that I may lose money, I viewed it as a learning opportunity. I am a firm believer that the best way to learn the rules is to play the game, so play the game I did.

This post is a look back. I’ll summarize my trades and returns over the last 6 months, then share some general lessons learned as well as go into detail into what I think is the best usage of options in stock portfolio.

Looking over my trading record, I made enough trades to have gained a decent amount of experience by trading both puts and call options on several different securities.

Here is a summary of my transactions:

Company Symbol Type Bought Sold % Gain
Intel NQAW Jan 17.5 Call 6/7/06 10/16/06 159%
Dell DLQAE Jan 25 Call 7/10/06 11/2/06 -6%
Taser QURAA Jan 5.00 Call 7/26/06 1/19/07 2%
Microsoft MSQDY Apr 27.50 Call 10/2/06 Not Sold Yet 104%
Intel NQKD Nov 20 Call 10/16/06 11/14/06 -13%
Intel NQAD Jan 20 Call 10/27/06
1/4/07 -19%
Garmin GQRAI Jan 45 Call 11/1/06 12/6/06 100%
Palm UPYBV Feb 12.5 Call 11/20/06 Not Sold Yet -42%
Western Digital WDCDW April 17 Call 12/12/2006 Not Sold Yet -21%
RadioShack RSHMW Jan 17 Put 12/12/2006 1/19/07 -100%

As you can see, I’ve had mixed results. While my winners have outrun my losers, I don’t consider stock options to be the holy grail of making fast profits on wall street. They are complicated, volatile, and often have lower liquidity requiring you to pay more of a spread when you go to buy and sell the contract.
What I have learned from six months of options trading:

  • Options are a tool you can use to maximize your investment returns
  • Options can be used to minimize your investment risk
  • Options can be used to leverage your cash on speculative plays
  • Options are highly volatile and very sensitive to market news
  • Options complicate trading by requiring that you predict both the direction of the price moment and the time frame that the movement will occur in

The largest lesson learned over the last 6 months while trading options is that stock options (either Calls or Puts) have a place in your portfolio, but should be reserved to a small percentage of your capital. Overweighting your portfolio with time and news sensitive options contracts can decimate your portfolio if a hiccup occurs in the market. I’d like to spend the rest of this post talking about what I see as the most valuable use of options in your portfolio. I encourage you to research stock options to learn about how you can effectively use them in your trading and investing.

Options have a place in your portfolio.
I will continue to use options to increase leverage in my portfolio in certain situations. There are times when the market overreacts or underreacts to a piece of news, and as an investor who believes differently from the general market, you want to act to take advantage of the market’s ‘mistake’. An effort to seize a short term gain using your own-unleveraged capital can be challenging. You may have most of your money tied up in other positions that you don’t want to liquidate for tax or fundamental reasons, or you may simply not have enough capital in your account to buy enough stock to make a significant profit. Using options to increase leverage and reduce risk on speculative plays, I view, is one of the main benefits of stock options.

Lets assume Microsoft announces earnings that upset the analysts. The price of Microsoft’s stock may sell off by 20% in one day. If you believe the sell off is overdone, you could buy the stock outright with cash and try to capitalize on the market’s overreaction. Microsoft is trading for $31/share and, after getting a 20% haircut, may be on sale for $25/share. If you believe the sell off was overdone and you think Microsoft should be around $28/share, you would want to buy the stock to take advantage of the $3 gain. To make $600 on the situation, you would have to buy 200 shares of Microsoft, this would require $5000 in cash. If that is not an option for you due to simply not having that much capital or having your capital tied up in other positions that you do not want to liquidate, you could turn to options.

If you suspect Microsoft’s price will recover to $28 in the next month, you may buy two call option contracts, 2 months out, at a strike price of $25, giving you the right to buy 200 shares of Microsoft anytime in the next two months for $25/share. You will pay a premium for this. Even though the stock is trading at $25 right now, you may have to pay a dollar per share in premium to buy the option, meaning you’d pay $100 per contract for a total of $200. Now, you control 200 shares of Microsoft stock for the next 2 months. Instead of it costing you $5000, it costs you $200. You don’t own the stock, but you have the right to buy it for $25 anytime in the next two months. If the stock goes to $28 as you predict, you can sell your call options for $300 each, bringing your profit to $400 on a $200 investment instead of making $600 on your $500 investment. You’ve seen an opportunity in the market, and you want to take advantage of it with as little money out of your pocket as possible. If Microsoft were to continue to decline and dropped to $23/share at the end of two months, instead of having tied up $5000 in capital for two months and having lost $400 on the transaction ($2/share times 200 shares), your call option will expire worthless and you will be out your $400. You’ve lost 100% of your investment, but your investment was small and you were able to keep your $5000 in other positions. As you can see, options are a powerful tool to use if you are making speculative plays. If you want to take a shot on a few speculative plays while keeping the bulk of your investment dollars in standard stock positions, options allow you to do it while limiting your risk.
I look forward to continuing to use options to increase the leverage of my portfolio and capitalize on situations where I believe the market has overreacted to certain events. While I will continue to use them, I will certainly back off of trading them so frequently. I achieved my goal of learning about how to trade options, how they behave in the market, and how they change based on the underlying stock price. While I was able to come out of my experiment with a profit, I believe the real value was in learning how to use these excellent tools in my portfolio going forward.

Trade – .QURAA – TASR 5.00 Jan 07 calls

I bought TASR calls for $2.65/contract on 7/26. The price of the stock was approximately $7.30 which puts intrinsic value of the option at $2.30 and about a .35 time premium for 5 months. The premium seemed low and TASR is a volatile and fundamentally attractive stock.

If you haven’t heard of Taser, I’ll give you a quick intro. They manufacture the high-voltage stun guns in use by consumers, police, and government. As an alternative to using a gun, I have to say I believe in the product whole heartedly. There has been a lot of bad press about wrongful death suits where people have died after being stunned. I cannot comment on the individual cases, but I have to rely on the fact that if the officer felt threatened enough to use the stun gun, they may have very likely used a regular gun instead.

Police departments all over the country have been purchasing and evaluating the stun guns. Orders continue to roll in and the company has some interesting concepts for future use of their technologies.

Trade – OMTR – Omniture

I bought Omniture on 6/28 for $6.18/share, shortly after their IPO. I’ve used this company’s products and have seen the amazing impact it can have on how a web business can operate. I know there are a lot of sites out there that still are not taking advantage of web analytics and I really believe the whole industry could really take off once it gets attention from additional investors.

Web Analytics allow web site owners to analyze user traffic patterns to their site. You can answer the critical questions required to run a web site such as “What do most people do when they visit my site?” or “At what point in the ordering process do most people exit the process, resulting in me losing a sale?”. These types of questions are simple to answer with Web Analytics tools and Omniture’s product suite is excellent. I’ve worked with their products, I’ve seen the implementation, and I’ve worked through their service channels, I’m confident they are a strong up and coming company and I wanted to get in as early as I could.

Trade – WVVI – Willamette Valley Vineyards

I bought Willamette Valley Vineyards (WVVI) on 9/18 at $6.10/share. I spent some time researching this company and, financially, it looked strong. I admit I know little about the wine industry, but it seems like a great company. They are small, approximately 100 employees.

They seem quite progressive in their environmental efforts, an interesting article was posted about WVVI on the Diesel Blog.

They also appear to be quite business savvy. Realizing it may be difficult to distribute their wines to customers directly due to their small production, they have a wholesale type approach of selling their wines along with others in an effort to become a one stop shop for customers to purchase wines from. This allows them to have an additional potential profit center while allowing them a much more attractive means to sell their wines.

Trade – .MSQDY – April 2007 27.50 call

I bought Microsoft April 27.50 calls for 1.75/contract on 10/2. The stock was trading at $27.35 a share. Intrinsic value was zero, time premium was 1.75 for 6 months. Microsoft has traded in a range for years without any really significant catalysts. Their earnings continue to be strong, their position in the industry is still very strong, and they have some huge catalysts on the horizon with Vista, Zune, and continued sales/improvements on the xbox360. Purchasing equivalent amounts of the stock would have cost a considerable amount of money and the calls seemed like a long enough period to maximize the gain on the hype and initial sales of Vista, both of which I think will be strong.

For all the negative press Microsoft gets for security concerns, monopolistic practices, and poor quality software, I think they do an exceptional job at providing a great OS for corporate desktops and consumers. They have a lot of very talented employees, behave fiscally responsibly, and are mature enough in the industry to be able to continue to dominate in their areas of strength.

I also believe the hype/threat of Linux on the desktop has waned. While many technically savvy people have dabbled in running Linux on their desktop, the vast majority of home and corporate desktop users continue to use Windows. I think having competition in the market is healthy and will force Microsoft to remain competitive, but I think, when it really comes down to it, most consumers and corporate customers will stick with Windows for the forseeable future.

Trade – WSSI – WebSideStory Inc.

I sold WSSI on 9/31 for 11.98/share. I didn’t hold the stock for long. I did make a slight profit on it, but I had decided I didn’t know enough about the company and had plenty of exposure to the web analytics field with my holdings in Omniture (OMTR). I bought the stock without doing enough research and decided that holding onto it was not the best use of my cash.

Trade – .NQAW – Intel Jan 2007 17.50 call

I sold my Intel Jan 2007 calls today for 4.40/contract. The option was deep in the money and had appreciated considerably since I purchased it. I was looking to get back some of the capital that was tied up in the contracts but wanted to maintain a long position so I sold the Jan 07 deep in the money and purchased November 2006 20 calls instead.

Trade – .NQKD – Intel November 2006 20 call

I bought Intel November 2006 20 calls for 1.95/contract. The thought behind this trade was to increase leverage buy buying additional contracts with the profits gained from the Jan07 17.50 calls which were deep in the money and tying up a large amount of cash.

Instrinsic value on the option was $1.70 so I paid $0.25 for the time premium of approximately 5 weeks. Reasons for the purchase:

1) Intel has recovered nicely off its lows earlier in the year

2) They are announcing earnings tomorrow (10/16) which are expected to be good
3) Time premium seemed quite low given the volatility over the coming weeks (Earnings from Intel and AMD)

4) The November calls at a higher strike price allowed me to buy twice as many contracts still in the money with a slight margin of safety

5) I expect the consumer and business PC industry to be strong over the next several months due to the upcoming Vista launch, I expect this upcoming demand to bring additional purchasers into the stock