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Friday, July 23, 2010

Establish Microsoft Corp. Covered Calls

A new covered calls position was established in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Microsoft Corp.(MSFT) covered calls as follows:

Established Microsoft Corp.(MSFT) Covered Calls for Aug2010:
07/23/2010 Bought 500 MSFT @ $25.47
07/23/2010 Sold 5 MSFT Aug2010 $26.00 Calls @ $.44
These transactions now complete the Covered Calls Advisor Portfolio for Aug2010 positions since the portfolio is now 96 percent invested in covered calls and 4% in cash.

Microsoft is the world's largest software maker, primarily as a result of its near monopoly position in desktop operating systems and its Office productivity suite. The combination of these two strongholds poses a formidable barrier to entry for competitors. The new product-cycle offerings in these two areas (Windows 7 and Office/Outlook 2010) are being well received and will provide nice growth catalysts for at least the next two years. Moreover, Microsoft has used its strong cash flows from these businesses to fund research and development in other markets, including home entertainment consoles and internet online advertising.

The company has five operating business divisions: Windows and Windows Live, Server and Tools, Online Services Business, Microsoft Business, and Entertainment and Devices. The Windows division includes the Windows operating system cluster of products, the Server and Tools division includes the Windows Server operating system and enterprise oriented products, the Online Services Business includes web-based advertising, MSN and the Bing search engine, the Microsoft Business Division includes the MS Office suite of products, and, finally, the Entertainment and Devices division features the Xbox 360 game console, video games such as 'Halo 3,' and software for mobile and embedded devices.
Microsoft has about 93,000 employees worldwide and is based in Redmond, Washington.

After the market closed yesterday, Microsoft issued an excellent June quarter earnings report that surpassed analysts' revenue and profit estimates. Each of their five divisions showed double-digit revenue growth while also keeping operating costs below expectations. Based on these results, this advisor believes that Microsoft continues to successfully streamline its cost structure, which will allow the company to show significant operating margin and earnings per share leverage.

Looking to the near-term future, the company should continue to benefit from the robust consumer demand for PCs, and improved business demand for PCs and servers. The company is poised to benefit substantially from the overlapping Windows 7, Windows Server, Xbox Kinect (Their new hands-free interface for the Xbox 360 game console that will be available before Christmas this year), Azure (Cloud Computing), Bing (Search), SharePoint (Web development for businesses), and Microsoft Office/Outlook 2010 new-product cycles during the second half of calendar year 2010 and into 2011. It appears to this advisor that Microsoft's impressive offerings in this product cycle are under-appreciated by both analysts and investors.

Analysts' current earnings estimates of $2.38 per share for FY 2011 (Note: Microsoft's FY 2011 ends on June 30, 2011) seem to understate Microsoft's earnings potential, which this advisor estimates will exceed $2.50. So a stock price catalyst in the form of several upcoming beat-and-raise quarterly reports is likely. Placing a historically conservative P/E of 12 on $2.50 earnings plus over $4.00 per share of net cash results in a $34 target price (a 33% increase above its current price). In short, given Microsoft's improving outlook, the stock is now cheap since it is trading near the bottom of its ten-year historical range on both a price-to-earnings (P/E) and an enterprise value-to-sales (EV/Sales) basis, thus providing room for some expansion in these multiples in the coming months. Finally, in addition to its attractive financial valuation, Microsoft is also an attractive investment because of its shareholder-friendly capital allocation policies (buybacks & dividends).

Soon after today's market open, MSFT was trading more than 1.0% below yesterday's close, and the Covered Calls Advisor took that opportunity to establish a covered calls position. Most importantly for this advisor, the Buy Alerts spreadsheet below (includes financials through the 4th quarter) shows that MSFT is a very attractive at this time since the total points rating of 17.86 is well above the Covered Calls Advisor's desired "Buy" threshold of 15.0.

Note: For expanded view, left click on the spreadsheet above.

Some possible overall performance results(including commissions) for the Microsoft Corp.(MSFT) transactions would be as follows:
Stock Purchase Cost: $12,743.95
= ($25.47*500+$8.95 commission)

Net Profit:
(a) Options Income: +$207.30
= (500*$.44 - $12.70 commissions)
(b) Dividend Income: +$65.00 =($.13 * 500 shares)
(c) Capital Appreciation (If stock price unchanged at $25.47):
-$8.95 = ($25.47-$25.47)*500 - $8.95 commissions
(c) Capital Appreciation (If exercised at $26.00): +$256.05
= ($26.00-$25.47)*500 - $8.95 commissions

Total Net Profit(If stock price unchanged at $25.47): +$263.35
= (+$207.30 +$65.00 -$8.95)
Total Net Profit(If stock price exercised at $26.00): +$528.35
= (+$207.30 +$65.00 +$256.05)

Absolute Return if Unchanged at $25.47: +2.1%
= +$263.35/$12,743.95
Annualized Return If Unchanged (ARIU) +26.0%
= (+$263.35/$12,743.95)*(365/29 days)

Absolute Return if Exercised at $26.00: +4.1%
= +$528.35/$12,743.95
Annualized Return If Exercised (ARIE) +52.2%
= (+$528.35/$12,743.95)*(365/29 days)

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