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SPAC Warrants 101: What Investors Need to Know

By Matthew Frankel, CFP® - Jan 6, 2021 at 6:42AM

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We break down one of the most misunderstood parts about SPAC investing.

Special purpose acquisition companies, or SPACs, have been a major investing trend over the past year or so. However, if you invest in a SPAC shortly after it goes public, you can invest in "units," which come with a share of common stock as well as a portion of a warrant to buy more. 

SPAC warrants are perhaps the most misunderstood part of SPAC investing, so in this Dec. 22, 2020 Fool Live video clip, contributors Dan Caplinger and Matt Frankel, CFP, discuss what SPAC warrants are and what investors need to know about them. 

Matthew Frankel: Warrants are the most misunderstood part of SPAC investing in my opinion. What a warrant does is it gives you the right to buy a share of stock at a certain price before a certain time. There's a lot more to it when it comes to SPAC warrants. Like I said, each unit comes with a fraction of a warrant, which eventually you can combine with the one. The exercise price is usually $11.50 for a SPAC. They're similar to options in the sense that you can exercise them for stock. There's a few key differences. Number one is that, whereas an option is just a traded instrument between two traders, a warrant, if you exercise it, actually provides capital to the company. When you exercise a warrant, you're buying another share of stock from a company for a pre-determined price. Do you have any insight on how SPAC warrants work before I get into the the auto exercise mechanisms and stuff like that?

Dan Caplinger: Yeah, the one thing I've seen with warrants is they confuse people more than anything else, this came up with the Nikola ( NKLA -4.35% ) SPAC before it went public. You have these regular common shares and you have these warrants. For a while the Nikola warrants were trading at what looked like a ridiculous discount compared to where the share price was. But you have to be aware of what the terms on the warrant are. Not all warrants allow you to exercise them and buy stock under the terms immediately. You have to wait until certain events happen. With the Nikola SPAC, the reason that discount was there was that there were enough warrants out there that once the warrants were exercisable, it dramatically increased the number of shares that were outstanding and what happened was that put pressure on the stock, the resulting dilution caught the common share price. What seemed to be arbitrage, wasn't in fact arbitrage available. That's the one thing I would say about that is kind of an esoteric technical aspect, but it's something to watch out for. Those who are familiar with options, they might see some pricing things that don't seem to make sense. But you have to look really closely at not just the terms of the warrants, but when they become exercisable in order to be certain whether you've got an opportunity or whether it's something that's just going to fade away.

Frankel: Yeah, they're usually not exercisable for some period after the business combination takes place, which could be a while. Even if a combination is announced and the common shares spike, Opendoor ( OPEN -3.64% ) is a good example of where that happened and there was an arbitrage appearing opportunity there. But there's no certainty that the merger is going to go through, there's no certainty that the prices still are going to be high by the time it gets there. Usually SPAC warrants have some provisions where the company can force them to be exercised, or can just exchange them for a certain amount of shares and stock known as the cashless exercise. Be sure to read the fine print when it comes to the SPAC warrants, usually $18 a share is the threshold the stock needs to be over before a company can just automatically force their warrants to be redeemed. There's also a lot of homework involved in that. You need to make sure that the company is not going to redeem your warrants, you're not just going to let them expire useless, and things like that. There's a lot of ongoing homework that needs to happen when it comes to SPAC warrants. For newer investors, I would advise buying either the shares or the units, not just gambling on warrants, which is what buying SPAC warrants are, it's gambling not investing.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Nikola Corporation Stock Quote
Nikola Corporation
$9.45 (-4.35%) $0.43
Opendoor Technologies Inc. Stock Quote
Opendoor Technologies Inc.
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