The Way I Am Playing SPACs (Theta Strategy)
Special Purpose Acquisition Companies (SPAC) also known as blank check companies we’re all the rage in 2020, and continue to be popular in 2021 as well.
It all started with VTIQ, which was the fist hyped SPAC I saw come across the board. The company was going to merge with Nikola Motors and the company promised that they we’re the next big thing (“The next Tesla” for hydrogen vehicles). Before you knew it the stock went from $12 to $90 and then crashed down spectacularly. After that we started to see more companies come onto the market through SPACs instead of the traditional route of IPOs.
Private companies can essentially become public without all the hassle and in a time where the easy money is flowing. That equals a great opportunity for private companies to raise cash and go public when valuations may be elevated.
When they first started popping up last year, I avoided them completely as when you invest in a SPAC prior to a deal announcement you are essentially just parking your cash that shouldn’t be going up in price.
But we have quite the phenomenon that has been going on for a while now. A SPAC will be announced with a net asset value of $10/share. and yet the shares will slowly get bid up even without any actual news.
“Net asset value,” or “NAV,” of an investment company is the company’s total assets minus its total liabilities. So if a SPAC comes along and says we have $300 million in cash to invest in a company to take public. Realistically without news of who they are investing in comes out, the ticker symbol for that SPAC should trade close to NAV.
But that is not what is happening in the real world. I don’t think what is happening right now will last forever, but from a trading aspect it seems like a valid speculative play.
In a way there is a floor on these ticker symbols before the deal announcement as if the company doesn’t find a target to acquire, then the fund would dissolve and you would receive back your portion of the NAV. So in an example where that is $10, that is what you would receive for each share you own.
Once a target company is announced is really the only time you can evaluate if you want to own that future company. Then this strategy would only apply for those companies you believe will continue to trade higher, but you want to lower some risk to the downside.
There are three main risks I see to SPAC investing as a whole:
– You buy close to NAV and the SPAC never acquires another company. Then you have essentially sat on cash without getting any return and you have lost the time value of money.
– You buy higher than NAV and the SPAC never acquires another company. Then you lost money on the shares and you lose out on the time value of money.
– A deal announcement is made and you decide not to redeem to receive its pro rata amount of the funds held in the trust account. Maybe the target is not attractive in the eyes of investors so the shares fall below the initial NAV as investors don’t have interest in the company. But you still have a chance to get out if you don’t like the company yourself.
Theta Strategy (Covered Calls)
Here is essentially the strategy to generate income from SPACs instead of holding cash in your account
– Sell covered calls on SPACs that are trading near NAV that have good management teams and also are targeting a favorable sector in the eyes of investors.
So let’s take a look at an example (Source: Yahoo Finance):
“Ajax I (NYSE: AJAX) has an all-star management team led by former CEOs and founders of well-known companies. The team includes 23andMe founder Anne Wojcicki, Instagram founder Kevin Systrom, Square Inc (NYSE: SQ) founder Jim McKelvey and Chipotle Mexican Grill Inc (NYSE: CMG) founder Steve Ellis. The SPAC is also led by Daniel Och and Glenn Fuhrman, who both worked at Goldman Sachs (NYSE: GS) and have experience with private investments in Coinbase, Github, Instacart, Robinhood, Stripe and Wish. The SPAC is targeting sectors that include internet, software, fintech and consumer.”
Below chart shows where it has traded YTD, and you can see there is volatility which presents different entry points.
This SPAC also has options available to trade. Currently the stock trades at $13.41 and has monthly options.
This means that you could sell a call to generate $110 by selling a $15 Call. You would first need to buy 100 shares at $13.41. So technically your max loss is $1341-$110 for $1231. But since it is a SPAC that hasn’t announced a deal yet the true bottom is $1000 so the max loss in that situation is $231 in my view.
The max win is +$159 (price appreciation) and +$110 for the call sold for $269 in 33 days. Meaning the ROI would range.
So if we say total collateral is still $1341, the ROI is $110/$1341 or 8.2% ROI in 33 days or 90% annualized.
The high range is $269/$1341ROI for 20% in 33 days or 221% annualized.
Also if it trades down to $12.31 and the call expires, we can just go ahead and sell another monthly call lowering our cost basis again. If you believe the team will eventually announce a good deal and the stock price jumps you have collected premiums along the way and get that price appreciation up to the strike price.
In my eyes the risk reward is pretty good and looks like a decent trade. Now once a deal is announced and you do this, it no longer has that NAV floor so is more risky in my eyes unless you believe in the company being acquired.
Also for me I have a watchlist of companies I’m willing to do this strategy with, but am waiting for a day where there is a pullback in the SPACs to buy shares into the weakness and get into selling calls against the position to lower cost basis and risk in the trade.
Overall I thought it was an interesting trade, but I don’t think this will exist forever. The opportunity is in the fact we are in a frenzy of acquisitions. Once that goes away, the premiums for the options will go down and the volatility in the SPACs prior to acquisition will go down.
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