As rumors have swirled around the potential Churchill Capital IV (NYSE:CCIV)/ Lucid Motors merger, CCIV stock has rocketed to heights rarely seen by unmerged SPACs (special purpose acquisition companies). Its $26 share price now puts it at over twice its capital base. If the merger falls through, CCIV shareholders will see their precious holdings drop back to $10.
Rarely has the stock market looked more like a massive game of Russian Roulette. Just as you don’t know whether there’s a chambered bullet in the revolver, no outsider could possibly know whether Michael Klein’s SPAC will merge with Lucid Motors. It’s glorified gambling at its finest.
But one peculiar group has made easy money from the speculation: options traders. Armed with some insight into SPACs, they have walked over regular investors to earn high returns with relatively low risk. Here’s how they did it, and how you can find the next CCIV.
CCIV Stock: The Wall Street Rumor Mill
“Buy the rumor, sell the news,” old-time Wall Streeters have long touted. And while you can safely ignore Wall Street advice 90% of the time, don’t overlook this gem — it pays to get in before the crowd. Just make sure you leave the party before everyone else does.
At first glance, CCIV stock fits this bill perfectly. On Jan. 11, Bloomberg first reported meetings between Churchill Capital IV, a blank-check company, and Lucid Motors, a fan-favorite electric vehicle startup. CCIV stock immediately shot up from $10 to $17. As rumors continued to swirl, shares hit $23 by the time the stock market closed one week later.
The mania seems like another case of retail investors gone wild. Why wait for a completed merger when you can buy in before everyone else? But as Nikola (NASDAQ:NKLA) and other “busted SPACs” have shown, what goes up can also come crashing down. And for unmerged SPACs like CCIV, the risk of the counterparty walking away means the downside is even more significant.
CCIV Stock: A Covered Call Options Darling
Look a little deeper, however, and one thing quickly becomes apparent. With the CCIV deal, it’s Wall Street pros who have been playing retail investors — not the other way around.
Following rumors of the merger, total open interest in CCIV call options ballooned to almost 400,000. To put that in perspective, similarly-sized/industry companies like Polaris Industries (NYSE:PII), a maker of popular off-road vehicles, have just 7,000 call options outstanding.
So, why did call options spike? The answer is simple: options traders were making low-risk money from the merger rumors.
SPACs and Options, Explained
CCIV and other blank-check companies have an interesting quirk: their value should theoretically stay above $10 pre-merger. That’s because sponsors typically price SPACs so that each share gets backed by $10 cash per share. If there’s no merger by a specific date, shareholders see their money returned.
Smart options traders will realize that this quirk means they can sell $10 covered call options with little risk of losing money. The strategy, however, is usually quite dull. Counterparties know the upside risk on SPACs, and the high call prices relative to the upside makes it hard to make money. But the moment the rumor mill starts, that’s when things get interesting.
Buy the Rumor, Sell to Fools
An options trader’s profit and loss lives and dies by market volatility. Calm markets are generally efficient, leaving most market makers wondering how to spend their day. But the moment stocks start moving on uncertainty, the dislocation can create exploitable inefficiencies.
In the case of Churchill Capital IV, merger rumors caused open interest to spike 20x more than comparable SPACs. In other words, while retail traders focused their attention on the will-they-won’t-they merger with Lucid, options traders were busy either 1) buying calls in anticipation of future gains, 2) selling calls, buying the underlying security to pocket the premium difference, or 3) making protective puts. With implied volatility spiking to almost 200% on merger news, it meant large profits for traders knowing what they were doing.
And if you want to find the next CCIV, keep your eyes peeled for upcoming SPAC mergers with strong upside potential. From QuantumScape (NYSE:QS) to Draftkings (NASDAQ:DKNG), successful SPACs have recently come around more often than you might expect.
What’s Next for CCIV Stock?
A word, however, of advice: if you’re not familiar with options, don’t try this at home.
Today, writing covered calls look like a far riskier proposition. Though a fall in implied volatility will help new entrants, the CCIV/Lucid deal’s merger risk means you can now lose a lot of money. A $4.50 fall in CCIV will wipe out the profit from writing a covered call, all else equal. Put another way, options traders have already walked away with the easy gains. With CCIV stock now 160% above its underlying collateral, it’s speculators and electric vehicle fans who are now taking the riskier bets.
As much as you, me, and my peers might love Lucid Motors and want to invest, the CCIV trade has become overrun by wily options traders who have likely already hedged their positions. You could still make money through buying CCIV (assuming the merger completes and is priced advantageously), but one lesson is clear: when in doubt, get in early and leave before the party ends.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
