Microsoft Corp (NASDAQ:MSFT) may rank among the most powerful tech giants in the world but compared to other hyperscalers, MSFT stock has been the worst of the bunch. That’s according to prominent investor Chamath Palihapitiya, who is commonly referred to as the “SPAC King.” Given the underperformance since the end of November 2022, Palihapitiya asserts that Microsoft has little to show for its investment in OpenAI.
Fundamentally, with expectations lowered, it’s possible that a lower magnitude of positive news could help create a disproportionate rise in MSFT stock. In addition, that Microsoft hasn’t apparently been able to make full use of the ChatGPT partnership may imply that there’s still growth to be extracted.
To be fair, the smart money hasn’t adopted this glass-half-full framework. Volatility skew, a screener that identifies implied volatility (IV) — or a stock’s potential kinetic output — across the strike price spectrum of a given options chain, indicates a heavy prioritization of downside insurance.
Specifically, for the March 20 expiration date, put IV is significantly priced higher than call IV at both ends of the strike boundaries. This setup indicates that insurance against downside tail risk (via out-the-money puts) carries a higher premium. On the upper strike boundaries, the put IV positioning acts as a mechanical short position, potentially to protect actual long exposure to MSFT stock.
However, the nuance is that IV positioning is relatively flat near the spot price. This setup appears to represent a classic institutional profile: downside hedging occurs in the wings, not near the epicenter of actual trading. As such, we may have an opportunity for an under-the-radar contrarian bet.
Establishing The Trading Parameters Of MSFT Stock
Where does this dispersion come from? Black-Scholes assumes a world where stock market returns are lognormally distributed. Under this framework, the above range represents where MSFT stock may symmetrically fall one standard deviation away from spot (while accounting for volatility and days to expiration).
Basically, Black-Scholes asserts that in 68% of cases, Microsoft stock would be expected to trade within the prescribed range 36 days from now. Franklyi, it’s a reasonable assumption, if only for the fact that it would take an extraordinary catalyst to drive a security beyond one standard deviation from spot. That said, we still don’t have enough information to help narrow down a directional debit-based trade with confidence.
At this point, we have more or less reached the maximum utility of first-order (observational) analyses. To extract even more insight, we would need to condition the observations to better estimate where in the dispersion MSFT stock is likely to land.
What we have here is a typical search-and-rescue (SAR) conundrum. Black-Scholes has identified a distress signal that went out somewhere in the Pacific Ocean. Further, the expected move calculation has established a search area where MSFT — playing the part of the shipwrecked survivor in this analogy — is likely to be found.
The problem, though, is that we have limited resources (and sunlight). We can’t dedicate a full-on search effort for one survivor so we must be smart with our resources. Given this dynamic uncertainty, that only means one thing: we need to use probabilistic math to account for influencing factors that can impact drift patterns.
This is exactly where the Markov property comes into play.
Using Science To Help Trade Microsoft Stock
Under Markov, the future state of a system depends entirely on the present state. Colloquially, forward probabilities should not be calculated independently but be assessed in context. Extending the SAR analogy, different ocean currents — such as choppy waves versus calm waters — can easily influence where a shipwrecked survivor is likely to drift.
Here’s how the Markov property is relevant for Microsoft stock. In the past five weeks (I’m narrowing the input of my model from the original 10 weeks), MSFT printed only one up week, leading to an overall downward slope. There’s nothing special about this 1-4-D sequence, per se. However, this quantitative signal represents a specific type of ocean current, which is likely to influence drift patterns of survivors caught in these waters.
From here, we apply a combination of enumerative induction and Bayesian-inspired inference to estimate where MSFT stock is likely to drift over the next five weeks. The idea is that we take observations from past analogs of the 1-4-D sequence and apply the median value to the current spot price, thus generating a forecasted outcome that takes into account the immediate behavioral state of MSFT.
If you accept the premise, we calculate that the security will likely trade between $402 and $423, with probability density peaking near $414. With this market intelligence, I’m tempted by the 410/415 bull call spread expiring March 20.
This wager requires MSFT stock to rise through the $415 strike at expiration, which appears to be a realistic target (assuming the validity of the model above). If the strike is triggered accordingly, the maximum payout would be over 117%. That would convert a $230 net debit (the most that can be lost) into a $270 profit.
Breakeven lands at $412.30, helping to improve the trade’s probabilistic credibility. Admittedly, this is a true contrarian wager because you’re going against the tide of both the public money and the smart money. Nevertheless, history shows that extended weakness in MSFT stock tends to resolve upward — and that’s what we’re banking on.
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