The VectoIQ-Nikola Deal Certainly 'Warrants' Your Attention
What the heck is going on with the VectoIQ stock vs. the VectoIQ Warrants? Let's tackle it right here.
By TIMOTHY COLLINS May 13, 2020 | 12:29 PM EDT
Stocks quotes in this article: VTIQ, DKNG
The most prevalent question I'm getting right now is what the heck is going on with the VectoIQ stock ( VTIQ) vs. the VectoIQ Warrants (VTIQW). I'll do my best to tackle that here.
VectoIQ Acquisitions is a special purpose acquisition company that is set to close on a purchase of Nikola Motor, a private company, in June. Nikola is a new entrant into the zero-emissions, electric heavy truck space. The company is a leader in the design and development of battery electric vehicles and hydrogen fuel-cell electric vehicles class 8 semi-trucks. It's focused on the development of next-generation smart transportation. The company's tractor trailers run on either battery packs or hydrogen fuel cells, devices that convert hydrogen gas to energy.
Discussing the company deserves its own space, so we'll circle back around to that this week.
The VectoIQ-Nikola deal isn't very different from the Diamond Eagle Acquisition Corp. deal for Draftkings.
The VectoIQ-Nikola deal isn't very different from the Diamond Eagle Acquisition Corp. deal for Draftkings ( DKNG) . Before the merger, in both cases, traders have three choices: stock, warrants, and units. The units are a combination of stock and warrants. The ratio is different in the VectoIQ case, so we'll see those aside right now. The stock and warrants appear to be the same based on the regulatory filing. One share of VectoIQ will translate to one share in the new company, to be called Nikola. One warrant in VectoIQ will become one warrant in Nikola. The warrant gives the hold the right to purchase a share of the underlying security at $11.50 for five years and can be exercised 30 days after the close of the business combination.
But there is a caveat to this: If the stock were to close above $18 for 20 out of 30 days following the business combination -- which means when the company officially becomes "Nikola" -- the company can redeem the warrants for what essentially amounts to .01. If called for redemption, the warrant holder can allow it to be redeemed (no one would), sell the warrants on the open market, or exercise the warrant and buy shares.
The challenge for some is there is no guarantee it can be a cashless exercise. Selling on the open market is selling, but it is different than a cashless exercise as it may not obtain the intrinsic value of the warrant.
For instance, as I'm typing this sentence, VTIQ is trading at $34.52 and the warrant (VTIQW) is trading at $12.81. It doesn't take a math genius to add $11.50 (the exercise cost of the warrant) to $12.81 and come to a total of $24.31. Obviously, $24.31 is significantly discounted to $34.52. In fact, one might believe VTIQW should be trading higher (it probably should), but note that this is currently like a European settlement option. The warrant can't be exercised early and the discount (intrinsic value) immediately realized.
Well, that's easy, right? Head over to the options market, buy an in-the-money put on VTIQ, buy the warrant, and arbitrage the difference.
Market makers aren't that stupid. First, you'd have to go out to July to be certain the deal closed and the warrant lock-up period expired. Then, you'd want to go into the money with like a $40 put or $45 put (those are the highest strikes) to eliminate all risk while still allowing for upside.
But here's the rub: The put premiums match almost penny for penny to the discount. In other words, your arbitrage opportunity disappears with a simple long put.
So, I'll short the stock? Well, good luck getting a borrow or not called early. Oh, and don't forget the enormous interest rate being charged on that borrow. You know what it amounts to through July? Yup, most of your arbitrage.
Where does it leave us?
If you have the cash to eventually exercise the warrants, they offer a safer entry into VTIQ. The stock has been squeezed tight as of late. There's a reason the puts are priced so high. Going from $14 to $34 means that we could be $25 or $40 by the end of the week. Heck, we could get there today or tomorrow, so the discount isn't a guaranteed gain. Instead, it is more like a hedge against a pullback. VTIQ can drop 30% and the intrinsic value of the warrant remains. In other words, the warrants have been rising more slowly, so it stands to reason they would fall more slowly.
In the end, I believe the inability to exercise the warrants before July in combination with an elevated options market that makes any upside arbitrage impossible right now has created this discount. Add in a short-squeeze that may not be maintained until July and you get some disbelief the price can remain this high (think of a Volatility Index spike to 90. We all believe it could keep going, but no one believes it will last). In short, if you want to play the short-term momentum on the belief of a squeeze, then VTIQ will be the higher risk, higher reward play. But if you want to build a position that still have short-term upside potential, lower capital risk, and a much bigger safety net, then the warrants (VTIQW) are the buy here.
I do own the warrants, but have been able to create an arbitrage with VTIQ puts because of the recent run. I will continue to watch for that opportunity, but the spreads are wide and the fills are ridiculously hard to get on VTIQ puts, so don't hold your breath.