"Are SPACs reliable candidates for our covered-call writing and put-selling portfolios?", asks Alan Ellman of The Blue Collar Investor.
This article will define and explain the anatomy of a SPAC so we can decide if they deserve a place in our conservative option-selling portfolios.
This is a company with no commercial operations (products or services) that is created to raise capital via an initial public offering (IPO) listed on the major stock exchanges. The goal is to locate a private company with outstanding growth potential. Once the target is established, the cash raised is used to merge with the IPO. Since there is no target company identified prior to the IPO establishment, SPACs are also referred to as blank check companies. The cash acquired from the IPO is placed in a trust and the SPAC has two years to locate a company. If no merger occurs after two years, the cash is returned to the investors. In many cases, the interest earned in the trust can be used as working capital by the SPAC. Investors receive units consisting of both common shares and warrants (rights to buy additional shares at a specific price).
Anatomy of a SPAC
- Sponsor (private equity firm, hedge fund etc.) completes an IPO
- Cash raised is placed in a trust
- Target company is located
- Shareholders vote yes or no
- If no, the SPAC is liquidated
- If yes, the SPAC acquires the company’s business model retaining the company name and changing the IPO ticker symbol
Examples of SPACs
Examples of SPACs in 2020
SPACs offer investors the opportunity to get in on the ground floor of an emerging company but because of the unknown nature of the potential merger it represents a risky investment. Therefore, SPACS should only be considered by those with a high risk-tolerance. Investors are giving the sponsor team a blank check and then hoping for the best. If and when a merger does occur, we must take our time to evaluate the business model and its growth potential before using these securities for our option-selling underlyings.
Learn more about Alan Ellman on the Blue Collar Investor Website.