Current Price: $19.69 (for hedged trade)
Target Price: $25 (for hedged trade)
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.