Time to Strike on Short-Term IBM, Microsoft Corporation Options?

The options market has historically underpriced the ability of International Business Machines Corp. (IBM) and Microsoft Corporation (MSFT) to make big moves

by Alex Eppstein

Published on Jul 25, 2016 at 2:26 PM

Dow tech stocks International Business Machines Corp. (NYSE:IBM) and Microsoft Corporation (NASDAQ:MSFT) recently made waves during their respective turns in the earnings booth. IBM's quarterly report was met with a flurry of price-target hikes, while MSFT gapped higher on its own round of bullish brokerage notes. Curiously, though, the options market still doesn't think these stocks have much potential to make outsized moves.

Let's start with IBM. Expectations are very high right now at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), with traders buying to open 1.77 calls for every put during the last two weeks -- in the 94th annual percentile. As alluded to, this optimism is well-deserved, considering the stock's fundamental and technical strength. Since bottoming at a five-year low in February, IBM stock has jumped nearly 39% to trade at $162.26. Also, the shares notched an annual high of $162.88 earlier today.

Yet, the options market is pricing in historically low near-term volatility expectations. Take for example IBM's Schaeffer's Volatility Index (SVI), which -- at 15% -- rests below 95% of all other readings from the prior year. On top of that, International Business Machines Corp.'s Schaeffer's Volatility Scorecard (SVS) registers at 86. In other words, over the past year, the market has tended to underestimate the stock's ability to make massive moves -- making now an attractive time to buy premium on short-term options.

The story on MSFT is pretty similar. Currently, the shares are knocking on the door of their 16-year high of $56.85 from late December. Plus, the tech stock has been on fire month-to-date, racing over 10% higher to trade at $56.50 -- including a 5.3% post-earnings bull gap last week.

The similarities to IBM don't stop there. MSFT's SVI of 16% registers at an annual low, suggesting short-term options are relatively inexpensive at the moment, from a volatility perspective. Plus, the stock's SVS of 77 indicates the shares have made bigger moves than the options market has priced in over the prior 12 months, suggesting now is an opportune time to purchase premium on short-term strikes.

Interestingly, options traders have been placing downside bets at an accelerated clip in recent months. Microsoft Corporation's 50-day ISE/CBOE/PHLX put/call volume ratio of 0.62 isn't far from the top quartile of its annual range. While some of this put buying may have been at the hands of shareholders hedging, an unwinding among "vanilla" bears could add fuel to MSFT's fire.

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