Microsoft reports earnings on Tuesday after the closing bell. Microsoft stock is anticipated to stay in a 4.9% range up or down after the results.
Microsoft has stayed within the expected range following three of the last six earnings announcements.
Traders who think Microsoft stock will not move too much following this earnings report could look at an iron condor trade.
Let's look at an example of how we might set up an iron condor over earnings.
Iron Condor Combines Bull Put, Bear Call Spreads
As a reminder, an iron condor is a combination of a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.
First, we take the bull put spread. Using the Jan. 27 expiry, we could sell the 230 put and buy the 225 put. That spread could be sold on Friday for around $1.20.
Then the bear call spread, which could be placed by selling the 252.50 call and buying the 257.50 call. This spread could be sold on Friday for around $0.80.
In total, the iron condor will generate around $2 per contract, or $200 of premium.
The profit zone ranges between 228 and 254.50. This can be calculated by taking the short strikes and adding or subtracting the premium received.
Maximum Return Nearly 67%
Because both spreads are $5 wide, the maximum risk in the trade is 5-2 x 100 = $300.
Therefore, if we take the premium ($200) divided by the maximum risk ($300), this iron condor trade has the potential to return 66.67%.
If Microsoft stock stays within the expected range, then the iron condor trade will work well. However, if the stock makes a bigger-than-expected move, the trade will suffer losses.
According to the IBD Stock Checkup, MSFT stock is ranked No. 3 in its group and has a Composite Rating of 53, an EPS Rating of 88 and a Relative Strength Rating of 26.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
