Pershing Square Tontine Holdings (PSTH) – Options Arbitrage – 27% Upside

Current Price: $19.69 (for hedged trade)

Target Price: $25 (for hedged trade)

Upside: 27%

Expiration date: June 2021

 

This is a variation of SPAC options trade that has been circling the investment world recently.

Pershing Square Tontine Holdings is the largest SPAC in history led by Bill Ackman. It has IPO'ed in July'20 raising $4bn. Redemption value stands at $20 per share. Due to its size and popularity, PSTH also has an active options market, which is quite uncommon for SPAC. These options currently trade at premiums, which offer a few interesting arbitrage plays. The idea here is to buy PSTH (current price $26/share) and sell June $25 calls, which currently trade at $6.31.

If until the expiration date PSTH price stays at or above $25/share (which I think is the most likely scenario), the trade will result in $5.31 profit, which translates to 27% upside within 6 months. If the stock price drops below $25/share, potential return gets decreased accordingly. One starts losing money only if the share drop below $19.69 levels, which is unlikely to happen due to $20/share redemption value (more details on downside protection below). The risk of losing money on this trade seems to be very limited.

The trade and returns for various scenarios are presented in the tables below:

Downside protection from trust value

All the time since the IPO, PSTH has traded substantially above its trust value. If no significant announcements are made until the option expiration, the share price is quite likely to stay at current levels (i.e. materially above $20/share) given a very positive market sentiment for PSTH, induced by recent hype/bubble in the SPAC/tech sectors and additional support from Bill Ackman's reputation.

Looking at the potential downside, the $20/share threshold is supported by the trust (redemption) value at which shareholders are allowed to redeem their shares. As long as this redemption possibility is available for shareholders, PSTH shares are very unlikely to trade below $20.

For this redemption possibility to disappear before option expiration, PSTH needs to consummate a merger before the 18th of June. This is unlikely to happen as a target hasn't even been found yet and the company currently has only 6 months to both find a target and close the merger. Apparently, for an average SPAC, it takes 4.5 months from finding a target and closing the transaction. The average time from SPAC IPO to closing of the merger is 15.5 months (PSTH IPO'ed in July'21). Moreover, PSTH is the largest SPAC in history (over $4bn in size versus over $340m for average SPAC in 2020) and is targeting companies of $10-$15bn in size. Mergers of these calibers are undoubtedly more difficult, take a much longer time, and could be prone to various delays. So overall, the chances of completing a merger by June look very slim.

And in the unlikely scenario that PSTH actually does manage to consummate a merger before the 18th of June, it is still hard to imagine shares dropping significantly below $20/share, when currently investor expectations are set so high (largest SPAC, first of a kind tontine structure, Ackman's involvement, target in tech space, trades 20% above the trust value which is very unusual). The current $6/share buffer adds some safety here as well.

 

Other ways to play it

There are a couple ways to structure this trade, which offer different risk/reward situations:

  • The same buy PSTH/sell calls trade could also be done with March expiration calls. They currently trade at $4.10, which puts break-even at $21.90/share. So the potential downside (to $20/share trust value) here could be 9%, while the maximum upside (if the stock stays at or above $25/share) is 14%. The risk/reward is much more evened, however, the timeline till pay-off is significantly shortened.
  • Instead of constructing synthetic short puts (long stock and short call), one could sell puts right away. This trade requires less capital, but also delivers provides lower upside and has breakeven point above $20/share.
  • All of the above-mentioned trades could also be structured with $20 strike options. The dynamics here are only slightly different, with breakeven far below $20/share but also far more limited upside.

 

PSTH and its targets

Following the recent SPAC hype, earlier this year, Bill Ackman has IPO'ed Pershing Square Tontine Holdings. PSTH raised $4bn at $20/share, while Ackman's Pershing Square Funds have agreed to additionally commit no less than $1bn with an option for further $2bn ($3bn in total). So PSTH is not your usual SPAC. Not only it is the largest SPAC in history, but it also structured more favorably towards common shareholders (i.e. it has a first of a kind tontine structure, which will allow shareholders who stay through a de-SPAC deal, to get additional redeemable warrants). PSTH will aim to take a minority stake in a company with a $10-$15bn market cap and is targeting "mature unicorns" and "high quality, venture-backed businesses". So far it is reported that PSTH approached and was rejected by Bloomberg and Airbnb. There are also rumors that the company had talks with Stripe, however, no official announcements were made on that yet.

61 COMMENTS

  1. g4734g

    Great idea thanks much…….tying to wrap my brain around why there is any premium for the March 20 strike puts…….unless they can consumate a deal in 12 weeks, if you get put you just turn your shares in?

  2. Jamal.Sydney

    This seems too good to be true. Any thoughts on why this opportunity exists?

    Another wrinkle I’m curious about: PSTH/WS trades at $9-10 and I think shareholders get dividend of 2/9 of a warrant or something if they hold thru deal. So you could say the stock ex the dividend is trading ~$2/sh lower. If the June 2021 20p can be sold for $1.50, then you’re effectively long at $18.50. But the “adjusted” floor price is 20 less 2. Do you know if the option exercise prices get adjusted downward if/when this dividend is paid? If not, then are you still creating it below adjusted trust value?

    1. EC

      I don’t know about SPACS and warrants specifically, but if it’s like the other corporate events I’ve seen, after the event, they’ll rename PSTH and its warrant into a new ticker, say PSTHN and PSTHW. They’ll create a new options chain for PSTHN, but they’ll keep the old options chain for PSTH. And then the deliverables for the PSTH puts/calls will now be PSTHN and PSTHW instead of PSTH.

        1. EC

          No, they’re not renaming the company. They’re just renaming the tickers as the contracts change. This way you can keep track of them. Also, some tickers will stop trading, or begin trading.

          For example, with Nikola:
          The SPAC units IPO’d were: VTIQU (VectoIQ Acquisition Corp – the blank check)

          The warrants and shares split into VTIQ and VTIQW (1 VTIQU = 1 VTIQ + 1 VTIQW. Actual ratios may vary). VTIQU stops trading.

          Merged with Nikola. VTIQ and VTIQW converts into NKLA and NKLAW. VTIQ and VTIQW stop trading.

          If you are holding these, your broker does all the conversions in your account. If you sold a put on VTIQU and it split, then instead of delivering VTIQU, you would need to deliver VTIQ + VTIQW (since VTIQU doesn’t exist anymore). Also, options might begin trading on VTIQ itself. So it’s important to keep track of what the options are for, especially after some corporate event.

          Here’s a good link:
          https://www.optionseducation.org/referencelibrary/faq/splits-mergers-spinoffs-bankruptcies

  3. charlies_almanac

    I’ve been looking into the adjustment for when stock goes ex the extra warrants and it’s very unclear. In my opinion the most likely outcome is there is no adjustment (so this benefits long puts/short calls and vice versa). This means that the OP’s Ida of buying stock and selling calls is better than the more obvious alternative which would be just to sell the equivalent put in my opinion

      1. Fa

        So selling June puts is better than selling put synthetically ( long share + short call) in order to optimise this “anomaly”, right ?
        I

  4. fishwithwings

    Little off topic, but it would be interesting to see some pre-merger SPAC ideas.

    1. ChrisZat

      I am with you fish. This sector has been working pretty well(until it doesnt) It does seem like there is limited downside.
      I am already long PSTH, DGNR, Bidding for EQD with a .40 spread, sold IPOB & IPOC. I buy for the backers. Also bought a broken one ERES which and Oil and Gas play.

  5. EC

    Also a little off topic, if you look at post-merger SPACS (after that fabulous NIKOLA) idea, a lot of them have a warrant/option mis-pricing. Risky to short the stock though (though you can use options) and risky if the warrants don’t become convertible.

    1. Tom

      EC – do you have any favorites in post-merger warrant vs stock trades? My biggest positions are in LAZR and IPOB.

      1. Fa

        I am looking for the list of post merger SPAC warrants not exercisable yet like LAZR? Do you happen to know where I could find this information? Is IPOB post merger too ?

        Thanks

      2. EC

        I think a risk in these trades is that the warrants need to become convertible. All the SPAC prospectuses I’ve seen state that warrants become exerciseable on the latter of one year after the SPAC IPO or 30 days after the merger. Also, the company has to file a registration S1 followed by a prospectus 424B3 to issue shares for the warrants. In the prospectus, it says this is on a best efforts basis – not guaranteed.

        So first check to see what that latter date is when the warrants become exerciseable. I think LAZR is Jan 2021. But they haven’t filed an S1 yet. I think IPOB is April 2021. Also, IPOB hasn’t begun trading post-merger yet. I am watching QS ( April 2021) and MP (May 2021).

        Another thing to be aware of is that just because they announce a business combination doesn’t mean the merger has happened yet. There is usually a few months before it is voted on and approved by shareholders. Then afterwards, there is a some time before it begins trading under a new ticker. So IPOB announced the merger in September, they will vote on December 17, and begin trading post-merger on December 21 (if all goes to plan) under OPEN.

        There is a spread with IPOB and its warrant, but it might blow up after the merger. Also, the warrants won’t be convertible until April 2021.

        1. Fa

          thanks a lot EC, this is very interesting….

          A couple of comments :

          i) SPACs universe is according to me quite dangerous and the best effort basis means that there is some risks in trading those warrants

          ii) Why do you expect MP warrants to be exercisable in May 2021 while the merger have been voted on November 17th ?

          iii) As far as QS is concerned, as you mentioned, the warrant become exercisable on the latter of 1 year after SPAC IPO or 30 days after the merger…… And 1 year after IPO is June 2021 not April 2021…. Did I miss something ?

        2. EC

          ii.) The prospectus for MP came out in May 2020, so the later of 30 days after the completion of their merger or 12 months after the the prospectus is May 2021.

          iii.) You are both right. QS is June 2021 not April. Thanks Fa and mcg for catching that!

        3. Fa

          Beside LAZR, MP and QS, do you know other SPACs which have announced merger and trade below intrinsic value?

          Thanks a lot

        4. EC

          QS got crushed today. I checked and found they’d filed an S1, 424B which became effective at December 30 close.

          Didn’t even think/ realize that they would do that.

          I don’t think the public warrants are exerciseable yet, but the other warrants (private) probably are.

          Same thing happened to MP, but not as extreme.

        5. Fa

          I read somewhere that private and public warrants should become exerciseable at the same time…..

        6. EC

          Fa, I wasn’t sure if you were right (you might have been), so I conducted a test by purchasing one warrant and submitting it for exercise, and Mark A. got back to me:

          Per the agent, the QS warrants are still not exercisable until June 30,2021.
          There is no estimated date of when these will be eligible for exercise at this time. As such, this ticket will be closed. You may submit your request at a later date.

          You may contact investor relations for more information.

          Regards,
          Mark A – Interactive Brokers Client Services

  6. dt

    My thoughts on ‘redeemable warrants’ whereby all non-redeeming shareholders will receive c. 2/9 of warrants (or more depending on number of shareholders that chose to redeem). With warrants currently trading at $10, this is potentially $2.1/share of value.

    1. These will matter only if transaction closes before option expiration (Jun’20). This is not the scenario I am basing the investment thesis.
    2. It is not yet clear if redeemable warrant distribution will be counted as a special dividend distribution by OCC and in turn whether option exercise prices will be adjusted accordingly. The distribution is likely to be treated as special dividend, but not 100% clear if this will be the case.
    3. Even if option exercise prices are reduced by the redeemable warrant distribution amount it should not make a difference for the outcome of the trade. The call might et exercised at c. $23 in stead of $25, but at the same time you receive an additional $2/share from the long stock position. So holding till option expiration or exercise should result in the same pay-off profile.

    In a theoretical case this should matter neither for upside nor downside scenarios as the reduction in option exercise prices should be coupled with an equivalent drop in the PSTH share price itself. However, this distribution will happen together with merger vote results announcement so the real-life scenario might be far off from the theoretical one.

    1. Fa

      Could you please explain why do you prefer to use a synthetic put ( long stock short call) rather than directly sell the June puts which are actually pretty liquid?
      It looks to me that the risk/reward per capital is much better using puts…..
      Thanks

      1. dt

        It is purely based on the option premiums – i.e. higher upside from using synthetic put vs directly selling a put.
        Current prices Jun’20 $25 Call: $5.6 (less $0.45 in the money portion) Put: $4.9 – the difference was even wider at the time of the write-up.

        Also I am not sure if the capital required to put up the trade is that much different. Selling naked puts also requires maintenance margin on 20% of the underlying price. So in the end it might be quite similar to selling covered calls depending on margin requirement for long position in a particular stock.
        https://www1.interactivebrokers.com/en/index.php?f=26660

        1. dt

          The same thing – synthetic put is slightly more expensive than a straight put.

  7. yuster27

    Folks can pick up some cheap protection through March by buying the $20 put for $0.25. Very cheap.

    1. nostradamus

      Protecting yourself against what exactly? Any (very small) deal risk surely solely exists between March and June. Protecting yourself until March seems like throwing away money; I’d be happy to write you those puts.

  8. g4734g

    I did sell those puts….march, 20 strike and did the bigger buy/write june 25 deal…..but always looking for risks I may have overlooked…..In your idea to BUY the march puts, what risks do you see, yuster27, that would take the stock below 20 given the option to trade the shares in to the company at 20 prior to deal consummation?

    1. yuster27

      Back in March many SPACs were trading below redemption value. I like the cheap protection for that.

      1. nostradamus

        But, protection against what? Worst case you get the shares put to you below redemption value, and you have to wait a bit to redeem at redemption value and still make a profit.

        1. g4734g

          Nostradamus, (or anyone else with SPAC trading experience), I’m new to the SPAC market, here is a very basic question. Can shares be turned in at any time prior to a deal consumption or are there certain windows that you have to execute this.

        2. mcg

          There are certain windows for redemption opportunities. Usually when there is a vote involved

  9. fishwithwings

    Is there anyway this can blow up on the option side (i.e. call option going up in price much more than the stock price)?

  10. EC

    I’ve been reading more into this to try to figure it out the angles. There’s a couple of interesting things I think is going on…

    The Pershing Square SPAC ipo’ed with a couple of conditions:

    1. Every unit PSTH.U IPO’ed for trust value of $20.

    2. Every Unit had a FREE detachable 1/9 of a 5 year Warrant with a strike at 23. Each 100 units will give you approximately 10 units.

    3. Every Unit has a FREE detachable 2/9 of a 5 year Warrant with a strike at 23 IF you hold through the merger.

    4. You can only redeem your shares pre-merger at the face value. If you redeem, your warrants get allocated out to the remaining shares, so if you hold through the merger, you might get additional warrants.

    5. During the merger, each unit is considered at its trust value of $20

    6. In September 2020, the 1/9 of a unit detached. PSTH.U split into PSTH and PSTH.W

    7. The warrant PSTH.W is now trading at approximately $10

    I think each of the option chains, particularly the December ones, are pricing as if post-merger.

    1. The trust value of PSTH is $20.

    2. The 22.5 December 2021 Calls are trading for around $9.50. This is about the same that the 5 year warrants are trading at. The time value of the 5 year warrants is almost zero, but that makes sense since you can’t convert them.

    3. PSTH has implicit Calls in it. If you have 100 shares of PSTH, the rest of the 2/9 warrants in it would be approximately 20 units, with a price of $10 (observed from the PSTH.W). Divided by 100 shares, this is an extra $2/ share. If you look at a chart of PSTH, it has almost never traded below $22.

    4. PSTH has an implicit Put at $20, because you can put the units at $20. The price of the 20 December 2021 Puts is $4.

    5. PSTH is trading at $26. Which is $20 for the trust value, $2 for its 2/9 warrants at 23 strike, $4 for its put at 20.

    This suggests to me that you could put on an almost equivalent position to the covered call using a synthetic stock (long Dec 20 call + short Dec 20 put) and short the March/June Call. The net return is a little less because you’ll pay the option spread and because you can earn interest (what little there is) on the capital that’s not tied up (The covered call position actually has opportunity cost of interest).

    This also suggests to me that any unit of a SPAC that is priced at its trust value (say $10 for a normal SPAC) BEFORE the warrant detaches, is undervalued because of the embedded warrant and put in it. We just don’t see them because there’s usually no options market for a SPAC unit. Since PTSH has an options market, we can price those embedded options.

  11. Supernova

    Good stuff. Thanks EC. And thanks for the idea dt. I come up with virtually identical payoffs for the short put vs. the short synthetic put. However, the return on investment is much higher for the short put because the margin requirement is only 20% of the notional value, whereas the capital invested in the synthetic put strategy requires an investment of 100% of the notional value (less the premium received). So the required investment on the short put is only $5.10 ($25.50 * 20%), leading to a gross return of 94% ($4.80/$5.10) and an IRR of close to 200%. This is 5x the return of the synthetic put due to the leverage in the options.

    Be careful out there. Do your own work. Derivatives are called weapons of mass destruction for a reason.

    One advantage of the synthetic put that I like a lot is the optionality provides. I hate short-term capital gains. The synthetic put provides some optionality to extend the trade to >12 months if Ackman hasn’t announced a deal by June…just keep your stock and roll the options out to December. Or if he does a deal you like you can keep the stock to avoid the ST cap gain hit. I think he has 2.5 years to get a deal done from inception date so it’s still early. And the hot IPO market isn’t helping him.

    1. Tom

      One advantage of the synthetic put is that it can be traded in an IRA. The straight put cannot be sold in most IRAs.

      1. g4734g

        Most IRA’s allow cash covered puts, which is the same amount as capital youd need for the synthetic puts.

  12. fishwithwings

    I’m guessing the least number of shares I can purchase for this trade is 100 (given option contracts are for 100 shares)?

  13. Tom

    For those that believe that the option strikes and/or underlying will adjusted to reflect the 2/9 dividend granted to holders when the deal is completed, how do they see this adjustment being made? It seems that the easiest thing would be to change the underlying to a share of stock and 2/9 of a warrant. However, depending upon when the deal takes place, the maturity of the options, and the stock’s performance the warrants may no longer exist (perhaps via forced conversion by PSTH). If the OCC makes some type of adjustment to the strike price to adjust for the stock trading ex-warrant is there precedent for how the warrant is valued (i.e., trading value of existing warrants when deal is completed, implied value of warrants in stock price, etc)?

    1. EC

      I don’t know. That’s an interesting question. But the options are on 100 shares so they may round down to the nearest whole warrant. I’ve also seen cases where there’s a small cash amount included. But I would say generally that the adjustment is fair i.e. no arb opportunities.

  14. Zulu Investor

    Hey Dt,

    Thanks for sharing this idea. Currently do not have a position in this, but out of curiosity – would my brokerage say IBRK, recognize that my call is covered if I buy 100 shares and sell one call separately? Or do I have to specifically write a covered call and do this trade simultaneously for both the stock and selling the call? I have Never done a covered call on my own before and I am worried that if my options does get activated, IBRK would not automatically recognize or liquidate the PSTH shares I already have.

  15. g4734g

    Interesting, depending on timing of PSTH-II, and how much your call, (assuming you are the seller) is in the money. Could be a catalyst for early exercise if folks want to be owners of record in order for this benefit to flow to them.

    1. rc99ar

      Can you expand on this a bit? When would exercising the call be advantageous to just going long the stock? (assuming a normal functioning market).

      1. nostradamus

        It wouldn’t. Buf if you already own the call it would be better to exercise and be a holder on record, rather than not exercise and not be a holder.

        Of course, assuming the call is deep in the money.

  16. ryanwalex

    It seems there are lots of SPAC’s where this strategy will work. Here is a link to SPAC’s with options: https://spacattack.net/options

    Some of them you can write the covered call for April and be below the redemption value.

    1. snowball

      Nowadays, pre-combination/searching SPACs typically trade at 2% discount to trust value.

      PSTH is special (regularly trading at >20% premium, and rightly so) because of the additional Tontine warrant value embedded in the shares, in addition to Ackman’s reputation.

      For the other run-of-the-mill SPACs, if below trust value is the baseline expected trading range, I am now finding the reward from option premium to be too small to cover the potential downside.

      And liquidity for SPAC options also has dropped off quite significantly, which makes it harder to enter/exit option positions and implement this strategy.

  17. rc99ar

    Has anyone done a redemption at trust value before? Are there any assurances that the funds are actually there or that the fees to redeem are not punitively high? I think a discount to redemption value could be warranted in some scenarios.

    1
  18. Michael Lax

    I don’t think there are fees associating with redeeming at trust value or past history of fraud in connection with trust funds. However, I have not done extensive research, comments are welcome.

  19. ryanwalex

    The funds are placed in an escrow account until shareholders redeem or vote for the merger.

  20. dt

    The transaction has been announced – PSTH will acquire 10% of Universal Music for part of the start and will continue to search for further business to combine with the remainder of the funds in the trust account.

    Proposed Transaction

    PSTH shareholders will own three separately traded securities following the completion of the Transaction and the issuance of rights by SPARC:

    1. their pro-rata share of UMG Ordinary Shares, which at cost, including transaction expenses, represents approximately $14.75 per PSTH share, before accounting for any dilution from PSTH Distributable Redeemable Warrants (the “Redeemable Warrants”);

    2. their pro-rata share of PSTH after the distribution of the acquired UMG shares (“PSTH Remainco”), which will have approximately $5.25 in cash per share, before accounting for any dilution from PSTH Distributable Redeemable Warrants; and

    3. one transferable five-year right per share (a “SPAR”) of Pershing Square SPARC Holdings, Ltd. (“SPARC”), which is expected to trade on the New York Stock Exchange.

    There is a lot to digest, but market will most likely be disappointed by this rather complex transaction and purchase of a rather stable (i.e. boring by today’s standards) business such AS Universal Music – seems to be far away from a story stock with a moonshot in the pocket that could excite the markets. Also this acquisition of 10% stake seems to be priced similarly to the sale to Tencent last year and comes at the time when Vivendi (UMG controlling shareholder) was planning to split-off UMG to its shareholders.

    https://www.reuters.com/article/us-vivendi-tencent-umg-idUSKBN28S0SR
    https://www.marketwatch.com/story/vivendi-shares-surge-16-on-plan-to-list-universal-music-group-11613391071

    So in a way, PSTH shareholders simply have a chance to invest alongside Tencent (at a slight premium to Tencent’s purchase price) in a company ahead of its public listing. I do not have enough info yet to judge whether that is a good or a bad investment, but at most this is a value type investment and not a high growth / high upside opportunity.

    My guess is that PSTH investors were expected far more from Ackman.

    Further details can be found in this press release.

    https://finance.yahoo.com/news/pershing-square-tontine-holdings-ltd-063000511.html

    1
    1. Terence

      What do you think is the best course of action? Hold? Close out the arbitrage? Buy on dip?

  21. dt

    We are closing PSTH case as the investment thesis described in this write-up has played out.

    There might be some special situation plays coming from the announced complex transaction and at current levels UMG/PSTH might be undervalued, however I have not looked at it deep enough yet to have any real opinion.

    With PSTH shares at $23.3 and June put options ($25 exercise) at $0.15, this idea resulted in 18% return in 6 months – not that far from the originally expected +27%.

    And all of it was as close to risk free as it gets – the only scenario where this trade could have incurred losses was PSTH consummating the transaction before the option expirations and subsequently shares dropping below the $20 trust value. And even in this scenario arbitrageurs would have had the option to redeem their investment at trust value.

    1. snowball

      dt,

      This trade idea is excellent. Thank you very much for the great idea.

      I’ve closed the trade, after PSTN rebounded to above $23.

      But I’ve been thinking about the optimal exit strategy for this trade.

      Yes, the trade was risk-free at entry when PSTH was at $25 and the option premium was $5.

      However, as the option premium gradually decayed over time (June put decayed to $1.5-$2 before the UMG announcement, while PSTH hovered around $25), should we have taken the profits and exit at that point, given that the margin of safety had become far smaller (in other words, the remaining $2 premium can protect against only a fall of PSTH to $23)

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