Microsoft (MSFT) stock is down over 20% year-to-date, including a recent dip of 4% in the stock in the past week. The stock now has some attractive income plays using covered call options and cash-secured put options.

The company reported stellar financial results on July 26 with strong revenue, operating income, and free cash flow growth. Its Azure cloud products powered much of this growth Moreover, the stock now looks undervalued.

For example, revenue rose 12% YoY and operating income was up 18%. In addition, its free cash flow (FCF) rose 9% YoY to $17.8 billion, representing 34.3% of its $51.865 billion in sales for the quarter. This is a very high FCF margin and implies that the stock could do well for the rest of the year.

Microsoft - Investor relations

Buybacks And Dividends

The company spent $32.7 billion on buybacks in the past year, 19% more than the $27.4 billion it spent last year. That represents 1.65% of its stock market capitalization. 

In addition, the company pays out a 62-cent quarterly dividend, which it is likely to raise in mid-September. This is because Microsoft has hiked its dividend every year in the past 17 years.

So, assuming the dividend rises to 66 cents quarterly, the annual $2.64 annual dividend will represent 1.00% of its stock price as of Aug. 29 ($265.23). So, combined with its 1.65% buyback yield, the stock has a total yield of 2.65%.

That implies that it could rise further this year. This is because Morningstar reports that the average total yield for MSFT stock in the past 5 years has been 0.60%. The stock would have to rise significantly to reach this average total yield. For example, if MSFT stock had a 1.325% total yield, it would rise by 100% from its present 2.65% total yield.

We can use this to help set target prices in call option income plays and cash-secured put option income plays.

Call And Put Option Income Plays

The Barchart table below shows that for call options expiring Sept. 30, the $290 call options provide a premium of $1.50 per contract.

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MSFT - Calls - Expiring Sept. 30 - As of Aug. 30

This means that the investor can make a monthly return of 0.566% (i.e., $1.50/$265.23 price) by selling this out-of-the-money (OTM) strike price call the 32-day forward call option. That represents an annualized return of 6.79%. Moreover, there could be an additional 9.33% capital gain for the investor if the stock rises to $290.00 by Sept. 30.

Moreover, investors can make money by selling (OTM) put contracts. For example, the table below shows that the $250 put option contracts for Sept. 30 trade for $4.15 per contract.

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MSFT - Puts - Expiring Sept. 30 - As of Aug. 30

This represents a 1.66% return on the $250 put price, assuming that the stock falls to this level and the investor has to purchase 100 shares at that price. You can see that this is a much more profitable way to create income than covered calls. On the other hand, there will be no capital gain as there could be with covered calls. 

Nevertheless, these are two profitable ways to create income with MSFT stock, given how undervalued it appears to be now.

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