What other tech stock to consider?

[corduroy]

The way I think of it is, if there is a big discount on warrants, the market is pricing in an expected drop after the merger to close that gap. Warrants and share price will usually reach close to equilibrium after the merger is completed.

 

[bkp_duke]

You have the math right - it is a massive discrepancy. The limits on these warrants are that they can’t be exercised until 1 month after the merger is done or Sept 30, 2021, whichever is later. That is why me rolling my sold calls to Jan/22 was key so I won’t have to deal with the calls expiring in the money before I can exercise the warrants. I fully expect the merger (with Lucid presumably) to be done before January 2022. Again my profit on this trade for any SP above $57.50 in January 2022 is $44.7 per share. If I started the trade today, that would be even higher. I am considering doubling up the arbitrage trade tomorrow depending on how much margin I have (sold calls can’t be covered by the warrants).

The one piece of this that is confusing me:
Are you selling calls against the warrants (i.e. like covered calls when you own the stock)?

 

[c041v]

This is all quite fascinating... I've never bought warrants, but it sounds like it can be done through through one's broker via a call? I did see that the price of Warrants jumped 66% today, so it appears they are catching up to the Share Price and any such discrepancy will remain static.

I second the question of selling Covered Calls against Warrants - is this what your are doing @pz1975?

 

[chronoreverse]

You can buy warrants just like stocks. It's when you exercise them to convert them into stocks that you need to call your broker.

 

[ckessel]

I second the question of selling Covered Calls against Warrants - is this what your are doing @pz1975?

Effectively, yes, since you can convert the warrants to stock to cover the call. It's sort of like having bought a call at strike $11.50 and selling a higher call (aka vertical spread option).

The difference is, near as I can tell playing in thinkorswim, is that the margin required is different. It doesn't see those warrants as covering the sold call, so you're limited by margin capacity for the sold call.

 

[bkp_duke]

Based upon @pz1975's post here:
What other tech stock to consider?

It looks like your warrants cannot directly be used as coverage for the sold calls. So, technically, it has to be covered by cash or margin in the account.

Basically, I need to call Fidelity and find out how many of the calls I can "sell" based upon my margin, and that will determine how many warrants I can buy.

 

[c041v]

Is that essentially selling a Naked Call? Not sure I have the permissions to do that, but if it is strictly margin based, I might... there's also some tax implications in the account I can do that in.

 

[bkp_duke]

Is that essentially selling a Naked Call? Not sure I have the permissions to do that, but if it is strictly margin based, I might... there's also some tax implications in the account I can do that in.

On phone with my broker running some hypotheticals on this trade. But what I'm told by Fidelity is that yes, it is essentially a Naked Call.

 

[chronoreverse]

Even without the options stuff the warrants still seem like a good deal if the merger goes through. The described trade though is eye-opening.

 

[pz1975]

Is that essentially selling a Naked Call? Not sure I have the permissions to do that, but if it is strictly margin based, I might... there's also some tax implications in the account I can do that in.

Yes it is a naked call. You need margin to cover it. Technically it is being covered by the warrant in that if the SP spikes you end up basically neutral in profit (+/-) but your margin will get used up if the SP goes up because the sold call is naked (in the eyes of the brokerage).

As for the theory that the SP may drop and cause a gap closure between the SP and warrant after a merger is announced, that is why the arbitrage is so nice because you are profiting off the gap and you eventually want the gap to fill so your profit is maximized. The gap can fill by the SP going down, the warrant price going up, or you exercise the warrant and then own stock at a price cheaper than if you had bought it outright.

Note there are obviously some risks in this whole trade, but IMO they are overall very small compared with the massive profit potential reward. Even if CCIV goes to zero, you can create an arbitrage where you still end up with zero loss (make the price of each sold call = the price of 100 warrants purchased).

 

[c041v]

I just realized that all of these questions were answered two weeks ago. I think I've got this mapped out now, but I'm going to write it out empirically to confirm my own understanding;

Buy: 100 x CCIV.WS* @ $11.50 strike for ~$30.00 = -$3,000
Sell: 1 x 21JAN22 $55 Call for ~$23 = +$2,300

The key here is having the required margin for the sold Call. When 30-Sep-21 rolls around and the SP is below $55 (but above $11.50), the warrants can be exercised for $11.50 each, meaning that each share would then have an immediate SP-$11.50 for up to a $36.50 profit per share. I could then decide whether or not to roll the Call or buy it back to restore Margin.

If the SP is below $11.50, I lose it all, but I'm only out $700.

If the SP is above $55, I could exercise the Warrants @ $11.50 each, and decide whether or not to roll the call, although that would mean I've also captured the $36.50+ per share profit as well.

*Is the ticker CCIV.WT or WS?

edit: Just saw the last post - A lower strike on the Call could indeed "zero" out the initial cost of the warrants, It would limit profit, but basically makes this a risk-free trade, aside from tying up some margin.

This is... brilliant.

 

[bkp_duke]

Yes it is a naked call. You need margin to cover it. Technically it is being covered by the warrant in that if the SP spikes you end up basically neutral in profit (+/-) but your margin will get used up if the SP goes up because the sold call is naked (in the eyes of the brokerage).

As for the theory that the SP may drop and cause a gap closure between the SP and warrant after a merger is announced, that is why the arbitrage is so nice because you are profiting off the gap and you eventually want the gap to fill so your profit is maximized. The gap can fill by the SP going down, the warrant price going up, or you exercise the warrant and then own stock at a price cheaper than if you had bought it outright.

Note there are obviously some risks in this whole trade, but IMO they are overall very small compared with the massive profit potential reward.

Thanks, this helps.

For those with Fidelity, I was on a call and they basically told me the following:
1) Level 4 or 5 trading required so sell Naked Calls. So I put in an application to enable this on my account.
2) They require that the warrants be purchased 100% in cash (no margin)


These are draft numbers, but here are bull and bear cases I am calculating, please correct me if any assumptions are wrong (numbers approximated at of time of this writing, subject to change based upon markets).

BULL CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2023 @ $28 = $280,000 premium collected
when warrants can be transacted for shares, then:
- buy 10,000 CCIV warrants @ $11.5 = $115,000 outlay (probably more cash)
- sell 10,000 CCIV shares @ $90 (number picked at random, pick your own) = $900,000 proceeds from shared
TOTAL: -$300,000 + $280,000 - $115,000 + $900,000 = $765,000 profit (minus any margin interest)

BEAR CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2023 @ $28 = $280,000 premium collected
when warrants can be transacted for shares, then:
- buy 10,000 CCIV warrants @ $11.5 = $115,000 outlay (probably more cash)
- sell 10,000 CCIV shares @ $10 (assumption that this is the floor for CCIV) = $100,000 proceeds from shared
TOTAL: -$300,000 + $280,000 - $115,000 + $100,000 = $35,000 loss (plus any margin interest)


Am I missing anything? Seems like a very limited downside, with very high upside potential.


What Fidelity could not confirm for me, since my account is not yet at Level 4, is if I can go through and take that 280k premium collected from the initial naked call sale, and use it to buy more warrants or not. That, apparently, is a complex calculation that the system has to do.



Thoughts?

 

[pz1975]

Thanks, this helps.

For those with Fidelity, I was on a call and they basically told me the following:
1) Level 4 or 5 trading required so sell Naked Calls. So I put in an application to enable this on my account.
2) They require that the warrants be purchased 100% in cash (no margin)


These are draft numbers, but here are bull and bear cases I am calculating, please correct me if any assumptions are wrong (numbers approximated at of time of this writing, subject to change based upon markets).

BULL CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2023 @ $28 = $280,000 premium collected
when warrants can be transacted for shares, then:
- buy 10,000 CCIV warrants @ $11.5 = $115,000 outlay (probably more cash)
- sell 10,000 CCIV shares @ $90 (number picked at random, pick your own) = $900,000 proceeds from shared
TOTAL: -$300,000 + $280,000 - $115,000 + $900,000 = $765,000 profit (minus any margin interest)

BEAR CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2023 @ $28 = $280,000 premium collected
when warrants can be transacted for shares, then:
- buy 10,000 CCIV warrants @ $11.5 = $115,000 outlay (probably more cash)
- sell 10,000 CCIV shares @ $10 (assumption that this is the floor for CCIV) = $100,000 proceeds from shared
TOTAL: -$300,000 + $280,000 - $115,000 + $100,000 = $35,000 loss (plus any margin interest)


Am I missing anything? Seems like a very limited downside, with very high upside potential.


What Fidelity could not confirm for me, since my account is not yet at Level 4, is if I can go through and take that 280k premium collected from the initial naked call sale, and use it to buy more warrants or not. That, apparently, is a complex calculation that the system has to do.



Thoughts?

You are close but 2 mistakes.

In the bull scenario, you still have to close out your sold calls at a loss (if the SP is $90). This reduces profit. Also, by choosing 2023, you will have relatively more time value left than if you had picked 2022. I think 2022 is better since there will be more time decay even though the initial sale price will be lower (for the same strike price). This is just about maximizing profit vs. minimizing loss though.

In your bear scenario, you don't have to exercise the warrants and sell the shares at a loss if the SP is way down. Even if the SP is at $10, the warrants will still have some value (maybe $0.75-1.00). So in that situation, it would be better to hold the warrants hoping for a rebound, or just sell them for $0.75 each. So instead of -$15,000 on that part of the transaction, you would end up +$7,500.

This is the beauty of this - the potential profit can be huge (mine is currently $44.70 per share) and the potential loss can be made very low or zero (mine is $1.30/share not including any residual warrant value).

 

[c041v]

Sounds like I need to call my broker...

Any idea of what the Margin Requirements on Naked Calls are?

 

[bkp_duke]

Sounds like I need to call my broker...

Any idea of what the Margin Requirements on Naked Calls are?

It usually varies by the security and your personal financial situation.

Fidelity today told me "25% and up" for this or something like it.

 

[c041v]

So instead of -$15,000 on that part of the transaction, you would end up +$7,500.

I think you missed a 1 here? It should read "So instead of -$115,000 on that part of the transaction, you would end up +$7,500."

Which means even in that bear case, one can't lose as the final value would be +$87,500 in that scenario.

I guess the actual potential loss in that scenario could be -$20,000 if the Warrant AND Share Price were both $0, which does seem quite unlikely (+ Margin Charges)

I checked my account and I can evidently place a Naked Call Order (although it says it will be routed for review), so past me must have been looking out for Present me...

 

[pz1975]

I think you missed a 1 here? It should read "So instead of -$115,000 on that part of the transaction, you would end up +$7,500."

Which means even in that bear case, one can't lose as the final value would be +$87,500 in that scenario.

I guess the actual potential loss in that scenario could be -$20,000 if the Warrant AND Share Price were both $0, which does seem quite unlikely (+ Margin Charges)

I checked my account and I can evidently place a Naked Call, so past me must have been looking out for future me...

No the -$15,000 was correct. I was combining the exercising of the warrants (-115,000) and the selling of the resulting shares (+100,000) in his example. Net was -$15,000. My point was that you don’t have to do that in 2 steps - just sell the warrants instead (+7,500).

 

[bkp_duke]

You are close but 2 mistakes.

In the bull scenario, you still have to close out your sold calls at a loss (if the SP is $90). This reduces profit. Also, by choosing 2023, you will have relatively more time value left than if you had picked 2022. I think 2022 is better since there will be more time decay even though the initial sale price will be lower (for the same strike price). This is just about maximizing profit vs. minimizing loss though.

In your bear scenario, you don't have to exercise the warrants and sell the shares at a loss if the SP is way down. Even if the SP is at $10, the warrants will still have some value (maybe $0.75-1.00). So in that situation, it would be better to hold the warrants hoping for a rebound, or just sell them for $0.75 each. So instead of -$15,000 on that part of the transaction, you would end up +$7,500.

This is the beauty of this - the potential profit can be huge (mine is currently $44.70 per share) and the potential loss can be made very low or zero (mine is $1.30/share not including any residual warrant value).

I was going to revise my original post, but waited too long. So based upon your feedback, I'm calculating it as this:

BULL CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2022 @ $22.50 = $225,000 premium collected
when warrants can be transacted for shares, then:
- close out 100 CCIV Jan 2022 Naked Calls @ $30 = $300,000 (estimate of what the call price may be if S/P hits $90)
- buy 10,000 CCIV warrants @ $11.5 = $115,000 outlay (probably more cash)
- sell 10,000 CCIV shares @ $90 (number picked at random, pick your own) = $900,000 proceeds from shared
TOTAL: -$300,000 + $225,000 - $300,000 - $115,000 + $900,000 = $410,000 profit (minus any margin interest)

BEAR CASE:
- buy 10,000 CCIV.WS @ $30 = $300,000 outlay (cash, not margin)
- sell 100 CCIV Naked Calls Jan 2022 @ $22.50 = $225,000 premium collected
- 100 CCIV Naked Calls expire worthless = $0
- sell 10,000 CCIV warrants @ $0.75 = $7,500
TOTAL: -$300,000 + $225,000 + $7,500 = $67,500 loss (plus any margin interest)


So playing with the numbers, if you go for the lower-valued call of Jan 2022, then your bear case loss is greater.

My head is starting to hurt. LoL. Do these numbers look right? It looks like it really comes down to finding a call to sell that can bridge the delta between the SP and the warrant price, and then hoping that the share price doesn't zoom up above that call price. Right?

 

[ckessel]

It looks like it really comes down to finding a call to sell that can bridge the delta between the SP and the warrant price, and then hoping that the share price doesn't zoom up above that call price. Right?

(emphasis mine)
To avoid limiting on the upside, don't sell the call. Selling the call makes the position a lot cheaper to get into though as it offsets the price of the warrants (and thus limits your potential losses).

 

[c041v]

To @pz1975's point though - You can go with a shorter dated call be on the right side of that theta decay for the next 11 months as the extrinsic value plummets to potentially 0 if you hang on long enough.

Granted, the profit is still capped unless you decide to roll the calls, but that's a good place to be in and sort of the point of this trade, I think?