One thing every investor learns during his or her development is that there many ways to play a stock. Picking a stock to trade is only the first part of investing. Once you decide which stock you want to trade, you have two basic questions that you need to answer.
The first is whether you think the stock is going to move higher or lower, then you have to decide on a strategy to profit from that movement. We are going to take Microsoft (MSFT) as our sample stock, and show you a few different ways you can play the stock.
Microsoft was once considered the hottest stock in the tech sector. In recent years the stock has been stuck in a tight sideways pattern in the upper $20’s, but a lot of analysts believe that the stock is about to break out to the upside.
One reason for the optimism is Microsoft’s highly anticipated new operating system, Windows 8. The world has been waiting on the new operating system, and it is finally here.
Whenever Microsoft releases a new operating system, it gets a good bump, and Windows 8 should do the same. The operating system is being hailed as the most major revision to Windows operating system in two decades, and is expected to result in jumps in computer purchases, and software upgrades.
For investors who want to play Microsoft, we are going to show you four different ways to do so.
1. Long the Stock
risk level = moderate
Simply going long Microsoft is the easiest way to play the stock. This is a bullish play, and involves just buying some MSFT stock. The stock has traded up 9.5% so far this year, but has been in a downward trend over the past month. The recent sell off we have seen has taken it from $31.45 on September 20 to its current price of $28.00. This creates a decent buying opportunity.
2. Bull Put Credit Spread
risk level = low
Using a bull put credit spread is a good way to play the stock because it gives you a little downside protection. This is a good strategy, especially if you are a believe that the company will benefit from the Windows 8 launch, but are not 100% convinced of the benefit it will have on the stock. You could set up a January 26/21 credit spread for a credit of 50 cents. In this trade you will be selling Janury 26 puts while buying the same number of January 21 puts. This trade would give you a target return of 11.1%, and offers you 7.2% of downside protection in case the stock trades lower.
3. Buy Calls on the Stock
risk level = high
This trade is for very bullish investors. If you are firm in your belief that Microsoft is going to trade higher on the Windows 8 launch, then buying calls offers your biggest upside potential. The risk of this is that you could lose 100% of your investment if the stock doesn't go higher. These types of trades are very risky, and should only be done when you are very bullish on a stock. You can buy a December 29 call for 45 cents, and in order for the stock to finish in the money it would need to trade up 3.5% between now and December 21. Considering the stock was trading about $31 a share just two months ago, it could easily head back towards that level if the overall NASDAQ reverses some of the losses it has seen in the past month. The option itself should rise in value if the stock trades higher, even if it does not trade all the way up to 29.
4. Buy Puts on the Stock
risk level = high
Not everyone is so convinced that Microsoft is going to bounce on the release of Windows 8. While early reviews have been positive, the real verdict will not be in until the operating system is in the hands of the general public and we start to see just how well it is accepted. The last few versions of Windows have been slightly disappointing, and if Windows 8 does not live up to the hype, the stock could indeed trade lower. You can bet on this by buying some puts on the stock. You can buy the December 26 puts for 32 cents, and you will be in the money if the stock drops by 7%. At the rate the stock has been trading in the recent month, it is definitely possible that it could continue heading towards the 26 level. Of course, it would not have to fall all the way to 26 to make you money. If you are right, and the stock continues to fall, you will start to see the option go up in value, depending on how much time is left in the trade.
As you can see, there are numerous approaches you can take with Microsoft. You first need to decide if you believe Microsoft is going to trade higher with the launch of Windows 8. Once you make that decision, you can opt to go high risk or moderate risk, depending on your level of conviction on your decision.
What are your thoughts on Microsoft? Is the stock getting ready to take off, or should we expect to see more downside in the months to come?
Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va. His articles typically cover big-picture events and forecasting what impact they will have on the stock market. In addition to writing for Fresh Brewed Media, Michael also wrote for AOL's BloggingStocks for three years, focusing most of his attention on the energy and technology sectors.