Why SPACs are great for wheeling, their option skew and risk/reward

Why SPACs are good for wheeling and their option call skew.

Why consider SPACs?

The premise of why we’re giving special consideration to SPACs is risk management. The assets of a SPAC is 100% cold hard cash, they IPO to raise money from investors, which is then used to acquire private companies, bringing them public.

In other words, if they IPO at $10/share. They keep $10/share in the bank. At IPO prices, their price book ratio is 1.0, and all of that book value is cold hard cash in the bank. No goodwill, assets, inventory or accounts receivables. All cash, which is returned to shareholders in full if they cannot find a target to acquire, or if enough shareholders ask for their money back.

SPACs = Zero Coupon Bond (above 100% NAV)

From the most pessimistic point of view I see them like a zero coupon bond. Now SPACs pre-merger often trades at a few percent premium because they do have upsides. You could view them as a zero coupon bond at 105% NAV. On rare occasions, like PSTH, they trade up to 30% above NAV. 

Why it’s good for theta gang (short puts/covered calls)

Now we’ve established that SPACs have a strong floor at NAV value. In that case, shouldn’t they have really low IV?

Strangely not, they tend to have IV of a tech company at minimum, and on occasions go above 100% IV. We got 2 great ingredients for a wheel target, high IV, solid book value as a fallback.

This leads into the thetagang strategy. 

1) Short Puts on SPACs close to NAV

Sell an ATM put on a SPAC at 110% NAV 6 weeks out, and collect 1.3% a week.

2) Covered Calls on SPACs close to NAV

On a 110% NAV SPAC, do a buy and write covered calls at 120% NAV. Often times, the call one strike higher is only barely less money than an ATM put due to high call skew. You receive slightly less premium but can capture potential upside.

Why SPACs have high call skew

If you look at the 16 SPACs we have on FDscanner, 10 of 16 of them have sufficient option liquidity to have an option skew. All 10 of them have call skew. PSTH tops the call skew charts and many of them hits the first page of our call skew index.

The reason is their limited downside at NAV, with uncapped upside, combined with SPACs being really hot in the market, causing speculation on what their potential target acquisition is (eg Stripe for PSTH), and that speculative fever goes in their options/shares. Also some SPACs have free warrants if you hold through merger. Warrants are OTM calls (in respect to NAV) with a few years before expiry. This further increases the upside ratio to downside.

As for thetagang, we can simply take advantage by doing covered calls. You will get slightly less money or a higher breakeven point but get to capture the upside between current price and your covered call strike.

I’ve been doing this for a while because I like the sound of 1% a week on a 110% NAV zero coupon bond. But do your DD, don’t overleverage and good luck. Also a note of caution, SPACs can occasionally trade below their NAV in an extreme bear market, you only have to look back to March 2020 for that.

All SPACs with Options