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Microsoft LEAPs Lower

By Nicholas C. Sparrow | Saturday, April 26th, 2008

Following this week’s lackluster earnings report, Microsoft (MSFT) stock closed Friday’s session off just over 6%.

But it’s not just the Microsoft (MSFT) share price that closed lower... Option volatility was “smoked”!

On the Thursday prior to the earnings announcement, the At The Money (ATM) implied volatility on Microsoft (MSFT) was trading at approximately 36%. By Friday night option prices were reflecting expected future volatility of closer to 26%.

In other words, options on Microsoft (MSFT) just got a lot cheaper...

Implied Volatility: What Every Options Trader Needs To Know

Most of the variables that go into calculating an option’s price are readily observed. The price of the underlying stock or the amount of time to expiration for example, are easily quantified.

Future volatility of a stock, however, is a very different kettle of fish...

Volatility, in its simplest terms, is the speed of the underlying stock. How fast it moves and how far it can potentially move. A slow moving market then, is a low volatility market.

Prior to the Microsoft (MSFT) earnings release on Friday, traders were uncertain about the impact on the stock price. They were braced for a potential shock that may have propelled the stock sharply higher or lower.

This, coupled with the recent bearish sentiment we have seen in the stock market of late, meant that for a while now Microsoft (MSFT) options have been relatively expensive.

That’s all changed now and given the current economic outlook, volatility is likely to remain relatively well supported going forward.

Let’s take a look at a bullish LEAP (Long-term Equity Anticipation Security) buying strategy on Microsoft (MSFT) to take advantage not only of a pull back in the stock price, but also lower levels of implied volatility.

Continued...

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