SPAC IPOs are not new. They have been around for decades (they had once been known as “blank check offerings”). But this year, we’ve seen a surge in this type of financing.
What is a SPAC then? It stands for Special Purpose Acquisition Company. Basically, it is a company that has no operations that raises money via an IPO (Initial Public Offering). The management team of the SPAC will then seek out an acquisition.
There are several reasons for the popularity for this kind of offering. One is the novel coronavirus pandemic. When the traditional IPO market dried up, Wall Street looked to SPACs to fill the void.
Also, another benefit: There is much less paperwork to get a deal done. And with so many people working remotely, this turned out to be extremely helpful.
So, for individual investors, what are some ways to invest in SPACs? What are the investing momentum strategies to juice up returns?
Let’s take a look at seven strategies to profit from SPAC IPOs:
- Story Stocks
- Be Disciplined
- Betting On a Deal
- Short Selling
- Position Size
Now, let’s dive in!
How to Profit From SPAC IPOs: Story Stocks
A common feature of a momentum stock is a company with a compelling story. And yes, when it comes to investing in SPAC IPOs, there have been a variety of deals that have fit the bill.
Keep in mind that the offering that sparked things came from Virgin Galactic (NYSE:SPCE), which had a very interesting story. The company, which has serial entrepreneur Richard Branson as its co-founder, is pioneering space tourism. Customers can take a 90-minute flight that reaches 50 miles into space. The cost for this is anywhere from $200,000 to $250,000 and 600 people have already signed up for flights — resulting in $80 million in deposits.
In terms of the SPAC, Virgin Galactic merged with Social Capital Hedosophia. The backer of this entity: Chamath Palihapitiya, who is a former early executive at Facebook (NASDAQ:FB) and a top investor in Silicon Valley. He personally invested $100 million in the offering.
Now, a momentum SPAC play does not have to be as bold as Virgin Galactic. But it should still have cutting-edge technology and the potential to disrupt a major market — or even create a whole new market. Such characteristics are the fuel that can help keep up the stock gains.
While fundamental analysis is important with momentum SPAC IPOs, there should also be a consideration of technical analysis. This involves analyzing chart patterns, volume indicators and so on.
It’s true that there are many techniques for this. Just some include head and shoulders, cup and handle, wedges, double bottom and more. So, yes, it can get confusing.
But when it comes to momentum investing, the focus is often on charts that, well, show mostly upward moves. They look like parabolic patterns that seem to defy gravity. These moves also have higher levels of volume, which indicate that the price action is built on a solid foundation.
Another strategy — which is fairly straightforward — is to make a purchase when the 50-day moving average is higher than 200-day moving average. You also want the stock price to be higher than the 50-day moving average. All in all, such conditions show lots of momentum in the stock.
How to Profit From SPAC IPOs: Be Disciplined
Nothing lasts forever — and this certainly includes momentum stocks. In fact, the gains are usually in short bursts of activity. And when the momentum starts to fade, the losses can be significant. A classic example of this is the dot-com implosion in 2000. There were many former high-fliers that quickly lost more than 90% of their value.
This is why you need to be disciplined with momentum investing. For the most part, whenever there are signs of weaknesses, it’s a good idea to lighten up on your position.
That said, what are some signs to consider? Let’s take a look:
- If you make a purchase and the stock falls 15% or more within a month or so, then this is a danger sign. The momentum trade could be nearing an end.
- The 50-day moving average has dropped below the 200-day moving average.
- You have made a 2X return in a few months. In other words, why be greedy?
Betting On a Deal
After a SPAC raises capital in the equity markets, there is a two-year widow to get a merger done. Until this happens, there is usually not much activity in the stock. So one strategy is to buy during this period.
However, like many other things, there are some risks. First of all, the mangers of the SPAC may be under pressure to strike a deal, which could mean targeting lower-quality companies or those with lofty valuations. Next, there is the risk that a deal does not happen and your investment will have languished.
Then, what to do? The critical factor is focusing on those SPACs with top-notch teams. This could be a group of managers from an investment firm or who have prior experience as operators.
To research the team, you can download the prospectus from the EDGAR website. Go to https://www.sec.gov/edgar/searchedgar/companysearch.html and enter the name of the SPAC. Then select the S-1 or S-1/A document. You will find the bios for the managers in the “Management” section. It is also a good idea to do other research, such as by checking out the LinkedIn profiles and media interviews.
How to Profit From SPAC IPOs: Margin
When engaging in momentum investing with SPAC deals, you can juice the returns with leverage. For example, you can borrow some of the cash to make a purchase, which is done by using a margin account.
They are easy to setup and operate, and the interest rates are also reasonable.
For example, here is how a transaction would work: Suppose you want to buy $10,000 of shares in DraftKings (NASDAQ:DKNG). You borrow $2,000 for the transaction through your margin account and put up $8,000 in cash. Let’s say that DKNG stock has a big move and your position is now worth $15,000. In this case, your return would be 87.5% ($15,000 divided by $8,000). By comparison, if you had did an all-cash transaction, the return would have been 50% ($5,000 divided by $10,000).
Nonetheless, there are some risks. If the stock price declines, then the losses will be magnified. Moreover, if the value of the position gets to a certain threshold, your brokerage firm will issue a margin call. This means you will have to put up more capital. If not, your position will be liquidated.
As a result, when thinking of margin, do not get too aggressive.
Momentum investing is often associated with stocks that keep moving in a bullish pattern. However, there are also momentum opportunities for stocks that fall too! We have seen this with several SPAC IPOs, such as Nikola (NASDAQ:NKLA).
How to benefit from this? You can use something known as short selling. Yes, this technique has been controversial. I mean, doesn’t it seem kind of wrong to bet that a stock will plunge?
It does. But keep in mind that many of the world’s top investors — such as those that run hedge funds — are good at shorting stocks.
Let’s take an example: You think XYZ Corp. is overvalued at $50 and you want to short 1,000 shares. To do this, you need to setup a margin account with your brokerage. This allows you to borrow 1,000 shares and sell them immediately. The $50,000 is placed in escrow in your account. After a few months, the shares of XYZ fall to $25,000 and you close out the short position. This is done by purchasing 1,000 shares at $25 each and then returning the shares to your brokerage. And you get to keep the $25,000.
Not bad, right? Definitely. But, like almost everything else I’ve mentioned, there are risks. If a stock continues to soar, you will keep losing money. This has happened to many short sellers in stocks of companies like Tesla (NASDAQ:TSLA). There are also margin interest costs.
How to Profit From SPAC IPOs: Position Size
Top momentum investors do have a healthy appetite for risk. But they also take measures to not let the levels get too excessive. If your portfolio is overloaded with momentum stocks, then the damage can be particularly severe if there is a bear market.
This is why it is important to monitor your trades and be willing to take profits on your big gainers. There also needs to be a focus on diversification. For example, one approach is to have a barbell strategy. This means that you balance your portfolio with value stocks or other conservative investments.
It is also a good idea to not take large positions in any given stock. A good rule-of-thumb is to not have it be any more than 5% or so. After all, if a momentum stock continues to surge, you do not need a large position to make a tidy profit.
On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Tom Taulli (@ttaulli) is an advisor/board member for startups and author of various books and online courses about technology, including Artificial Intelligence Basics, The Robotic Process Automation Handbook and Learn Python Super Fast. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.