Microsoft rally brings likely hedges against sharp reversal

Stock Market Predictions

(Global Markets) - Investors worried about a big drop in Microsoft shares over the next few weeks appear to be picking up insurance in the software giant.

Microsoft Corp (MSFT.O) hit levels not seen since April 2008 earlier this week, and the stock is up 21 percent since the beginning of the year, bringing out unusually high interest in the options market from investors.

The option activity popped up early on Friday and in the put

contracts with a strike price far below the value of the stock, which ended 0.35 percent higher at $31.48.

The U.S. equity market has performed well all year, with the S&P 500 index rising 8 percent in 2012. Technology shares have led the way, particularly big-cap names, as the Nasdaq 100 .NDX is up 14 percent so far this year.

The transactions involved the puts, giving the right to sell the stock at $27 each by March 16 expiration, a 14 percent decline for the shares in the next three weeks. But these out-of-the-money puts have such a low probability of being profitable they could be seen as no better than a lottery ticket.

"We are seeing heavy volume from the buy side on Microsoft's far out-of-the-money puts, particularly the March $27 strike," said TD Ameritrade chief derivatives strategist J.J. Kinahan.

The $27 strike carried total volume of more than 44,700 contracts traded on Friday, nearly six times their open interest, according to options analytics firm Trade Alert.

It does look like the March $27 puts were bought at an average premium of four cents per contract, said Interactive Brokers Group option analyst Caitlin Duffy.

"There does not appear to be any obvious catalyst for this put buying so it could be a big holder of long stock hedging his position and unwilling to incur a big cost to do so," Kinahan said.

The March $27 puts have low odds that Microsoft would be under that strike price by March expiration. These puts appear to be equivalent to catastrophic insurance and "as such, there is a low probability of this happening," Kinahan said.

Option traders often look at the delta of the option, which measures the change in the option price relative to the move in the underlying stock price.

"The delta of the March $27 put is minus 0.03, which tells us that the options market is pricing in a 3 percent chance that the option will be in-the-money by expiration," said Steve Place, a founder of options analytics firm investingwithoptions.com.

"The trade may be a hedge initiated by an investor long the stock or a low-cost, low probability bearish bet on a pullback in the shares by March expiration," Interactive's Duffy said.

In all, about 99,000 puts and 73,000 calls traded on Friday in Microsoft, data from Trade Alert showed.

(Reporting By Doris Frankel; Editing by Chizu Nomiyama)