In the first part of this article, we looked at SPACs and how they work. Now we'll get to the more useful part of the discussion -- some techniques for extracting value from SPAC shares.

As mentioned before, SPACs are often sold in units; common stock and warrants trade separately. These pieces can often be arbitraged against each other if the current trading prices aren't priced properly. For example, one unit is often equivalent to one common share and two warrants -- currently, Jamba Juice units (NASDAQ:JMBAU) trade at $14.45, Jamba common shares (NASDAQ:JMBA) trade at $10.13, and Jamba warrants (NASDAQ:JMBAW) trade at $4.27. In this case, each unit is comprised of one common share and one warrant. So, by definition, the price of the common and the warrant ($10.13 plus $4.27 equals $14.40) should equal the unit price of $14.45, but the spread of five cents is not large enough to exploit.

In general, though, it's hard to capitalize on mispricings because of wide bid-ask spreads, low volumes, and the lack of shares to borrow for shorting purposes.

Discount to liquidation value
This is probably the most useful thing about a SPAC. SPACs tend to trade at less than their liquidation value following their IPOs. This is kind of similar to how closed-end funds (CEFs) trade at discounts to their liquidation values, since investment banks only get paid once to sell shares in SPACs and closed-end funds. Thus, the initial public offering of a SPAC or CEF is usually accompanied by a road show to get investors interested in buying shares. Once the shares are sold, the investment bank and CEF or SPAC insiders have their money and don't need to spend any more time getting investors psyched up. Thus, investor interest wanes, and shares often fall to below liquidation value.

The key difference between CEFs and SPACs is that SPAC holders have a short-term catalyst for getting their money back -- if they vote to reject the subsequent acquisition deal (or if the 18-24 month time period expires), then they get their money back. Thus, if investors wait until a SPAC's shares trade at less than liquidation value, they can often get "better than cash" returns by investing in discounted SPAC shares.

For example, if a SPAC's shares are trading at a 4% discount to liquidation value, and management only has six months left until expiration, then at worst, the SPAC shareholder will get a roughly 8% annualized return. If management doesn't make a deal, then the shares expire, and the SPAC shareholder gets a 4% return in 6 months, which equals a 8.16% annualized return (1.04 squared minus one). On the other hand, if management makes an unappealing deal, then the shareholder can simply vote against the deal to get his or her money back.

Optionality is the other key ingredient that makes SPAC shares interesting. If an investor buys SPAC shares at a discount to liquidation value, it's a "heads I win, tails I get my money back with interest" situation.

For example, if you buy shares in a SPAC with a $5.60 liquidation value at $5.40, with six months to go until expiration, then at the worst, you'll get roughly $5.60 in six months. That's a 3.7% return, or 7.5% annualized. This is much better than any money market would pay, so it makes a lot of sense to put your idle cash in this SPAC.

On the other hand, if management makes a great acquisition, then your shares might be worth much more than $5.60. This is known as optionality -- you basically get a "free call" on management's ability to either do something very smart or get very lucky. For example, shares in SPACs of Services Acquisition, which bought Jamba Juice, Endeavor Acquisition (AMEX:EDA), which is in the process of buying hot retailing company American Apparel, and Hill International (NASDAQ:HINT) traded up after their acquisitions were announced. The possibility for a SPAC to become the next Jamba or American Apparel is a free option for investors who buy discounted shares of SPACs.

In conclusion
Because SPACS are embedded with both put options (where investors can vote to reject the acquisition deal and get their money back) and call options (if management makes a great acquisition), they can be very useful parts of an investor's portfolio. If bought at a discount to liquidation value, SPAC shares can also be a great way for investors with idle cash to juice their yields and receive free optionality.

For related SPAC commentary:

Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.