Shares of special purpose acquisition company Digital World Acquisition (NASDAQ:DWAC) continue to consolidate in an ever-narrowing trading range. The battle between the bears and the bulls in DWAC stock is certainly evident in the sideways price action.
My focus in this article won’t be about the merits of the bullish and bearish cases though. Both sides make valid points. Instead, I wanted to point out how to take advantage of an options anomaly to buy shares at big-time discount. The option trade may be daunting to some. The benefits, however, are worth the effort once you grasp the concept.
InvestorPlace Contributor Faizan Farooque recently cautioned about DWAC stock . He recommended trimming out of some shares. Some of the issues with Digital World were highlighted in the article.
Our own David Moadel had a more bullish outlook and cautioned not to underestimate the upside for DWAC stock. He classified the stock as long only to avoid any short-squeeze shenanigans.
Truth be told, DWAC stock at the core is largely a bet on the ongoing popularity and staying power of the Trump brand. Believers, though, should carefully consider the benefits of the option strategy laid out below.
Don’t Sell, Just Switch
Luckily, the options market provides a much better solution to lower your risk than trimming out of some of your DWAC shares and potentially missing the next rip higher.
Digital World is one of the most heavily shorted stocks going. The latest figures show short interest at just over 13% of free float. The cost to borrow rate is an eye-popping 116%. This means traders who short the stock have to pay heavily to borrow the shares.
Both of these numbers are a big increase from Jan. 24 when 11.2% of the float was shorted and the borrow rate stood at 103%.
So why do we care about about short interest and borrow costs if we aren’t looking to short DWAC stock? We care because it makes the price of put options on Digital World extremely expensive versus the price of calls.
How to Buy DWAC Stock at a Discount
Synthetic long stock, or a long combo, is created by buying a call and simultaneously selling a put of the same strike and expiration. For example, buying the June $170 call in Apple (NASDAQ:AAPL) and selling the June $170 put in Apple is the same as buying 100 shares of AAPL stock.
Let’s do a comparison between EIX and DWAC to illustrate the point. Both stocks were trading at roughly the same price just below $70 on March 29.
The Jan $70 calls for EIX were trading around $5.20 and the puts were around $6.20. Buying the calls and selling the puts would bring in about $1. Effectively you are long the stock at $69 ($70 strike price less $1 net credit for the combo). Note that the implied volatility (IV) was the same for the calls and puts at 23.
Now let’s look at DWAC. The Jan $70 calls were priced near $15 while the Jan $70 puts were trading about $50. Buying the calls and selling the puts would bring in a massive $35 as a net credit.
Effectively you would be long the stock at $35 ($70 strike price minus the $35 net credit for the combo). Note the implied volatility (IV) on the puts was almost double the IV on the calls. This is because DWAC is hard, if not impossible, to borrow. This results in the borrowing cost being well over 100%!
Longer-term investors looking to buy DWAC stock would get a nearly 50% discount using the combo strategy in place of buying shares outright. Current holders of Digital World can sell their shares and switch into the long call/short put strategy and receive the same discount.
The caveat is that you need to hold the position until expiration to receive the full discount. Selling shorter-term out-of-money call spreads could further reduce your exposure while still maintaining a bullish stance.
Traders and investors who believe in the long-term viability of DWAC stock would be much better served taking advantage of this options anomaly than simply buying shares.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
