It’s the end of another week of trading. The S&P has gained 2% through the first four days of the week. As I write this, the index futures are down in pre-market trading. With little consequential news on tap, it could be some profit-taking after earlier healthy gains.
Investors continue to contemplate what Trump’s tariffs will mean for their portfolios. That should mean above-average volatility in the near term. Investors will adjust appropriately once President Trump has laid his tariff cards on the table. Until then, it’s all speculation.
Yesterday’s unusual options activity--I define it as options expiring in a week or more with Vol/OI ratios of 1.24 or higher--there were 1,274 with 828 calls and 446 puts, a very bullish put/call ratio.
Rather than discussing a stock with a high Vol/OI ratio from yesterday’s trading for today’s commentary, I’ve decided to go way out to December 2027, nearly to the end of Trump’s second term in office.
The two options with the highest DTE were a Microsoft call and a put that expires in 1,058 days on Dec. 17, 2027.
Those new to options investing, and even seasoned veterans, might have difficulty deciphering the options strategy on display. I know I did.
Have an excellent weekend. Go Commanders!
The Microsoft Options in the Spotlight
First, MSFT is an excellent buy-and-hold stock for any portfolio. Millions use its products and will continue to be used long after I’m gone. It’s a no-brainer. It’s why, according to VettaFi, it is in the top 15 holdings of 442 ETFs.
Here are the two options in question.
It’s not often that you see unusually active options for such long durations. About two years is typically the longest DTE you’ll see. I digress.
You’ll notice that neither the call nor the put has high volumes or Vol/OI ratios. The call’s Vol/OI ratio of 2.33 was around the 750th spot out of 1,274, while the put was slightly higher in the 427th spot. Microsoft’s 30-day average options volume is 260,764, which were tiny contributions to its options trading Thursday.
Starting with the $640 call, it is 43.27% out of the money (OTM). That’s considered deep OTM because the strike price is more than one strike price above the share price. The put is 27.60% in the money (ITM). It’s deep ITM because the strike price is more than one strike price below the share price.
So, the task here is to decipher what options strategy is used in this call/put combination, if any.
The Possible Options Strategies
There are two sides to every trade: one is long, and the other is short. Some are bearish, and some are bullish.
Investopedia lists 10 options strategies every investor should know: Covered Call, Married Put, Bull Call Spread, Bear Put Spread, Protective Collar, Long Straddle, Long Strangle, Long Call Butterfly Spread, Iron Condor, and Iron Butterfly.
The call most certainly could be a covered call. If you own Microsoft, you would sell a call for $34 in premium. However, the annualized return on the premium would be just 2.6%, which is hardly worth the effort.
The put could be a married put where you already own the stock and buy a put to protect the downside. The only problem is that you are deep ITM, so your cost is high at a $133.95 ask price (30% of the share price).
Your net debit is $580.66 [$446.71 share price + $133.95 ask price], while your maximum loss is $10.66 [$570 strike price - net debit]. In this situation, you want the share price to increase by $133.95, or the cost of the put.
This is a possible winning strategy for the put.
A bull call spread involves buying the $640 call for the $35 ask price and selling a call at a higher strike price expiring in January 2027. There isn’t one available.
A bear put spread involves buying the $570 put for the $133.95 ask price and selling a put at a lower strike price, expiring in January 2027. There are three possibilities.
All of them are worth considering. However, I’d go with the $500 put. It has the lowest maximum loss (net debit) of $52.40 with a $17.60 maximum profit [$570 strike price - $500 strike price - net debit].
The fifth strategy is a protective collar. This is when you own the stock; you buy an OTM put (protective put) and sell an OTM call (covered) because you already own the stock.
Working with at least one of the two unusually active options, you would sell the $640 call for a $34 premium (bid price) and simultaneously buy an OTM put. That’s not the $570 put. Let’s go with the $400 put below the share price.
It has a $40.10 ask price. This would create a net debit of $6.10 [$34 bid - $40.10 ask], making it a debit collar. The maximum loss would be $52.81 [$400 strike price of put - $446.71 share price - $6.10 debit]. The maximum profit would be $187.19 [$640 call - $446.71 share price - $6.10 debit].
If you go with a put strike that’s even lower, say $350, the trade becomes a credit collar, where the call premium ($34 bid) is higher than the put ($26 ask) for a net credit of $8. The maximum loss would be $88.71 [$350 strike price of put - $446.71 share price + $8 credit]. The maximum profit would be $201.29 [$640 call - $446.71 share price + $8 credit].
Of the two, I’d go with the debit collar.
The sixth strategy is a long straddle. This is when you buy a call and put options at the same strike price and expiration date. You do this because you expect a big move in either direction. Generally, you want the call and put strike prices close to the share price. That isn’t this.
Next up is the long strangle. It involves buying an OTM call and an OTM put at a lower strike price with the same expiration date. The put is ITM, so it doesn’t work. However, you could use one of the two. Like the long straddle, you’re expecting a big move; you’re just unsure which direction.
Here’s the $640 call at current prices:
Based on yesterday's $446.71 closing price, you’d have to buy a put with a strike price of $445 or lower. I will go with the $250 strike, about the same amount down OTM as the call OTM.
Your net debit on this is $43.05 [$640 call ask price + $250 put ask price]. That’s slightly less than 10% of Microsoft’s share price. You make money if the share price drops below $206.95 [$250 put strike - net debit] or rises above $683.05 [$650 call strike + net debit].
Let’s say its share price is $1,000 at expiration. You exercise the call for a $316.95 profit [$1,000 - $683.05]. That’s an annualized return of 254% [($316.95 / $43.05) * (365 / 1,058)].
Bingo, we have a winner. I’ll cover the three other multi-leg options strategies another time.
