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Nikola Corporation (NASDAQ:NKLA) has been on an absurd run to the point where its market cap has increased to $23 billion based on Friday's close of $64. I'm not going to get into what an insane overvaluation that is for a pre-revenue company. There are already plenty of articles on Seeking Alpha for that. What I will explain are the mechanisms of this special purpose acquisition corporation, or SPAC, listing and why this will guarantee a crash in the stock price in the near future as the stock's float increases. The high implied volatility on put options compared to calls and the warrants trading well under their intrinsic value are two signs that also point to an imminent decline.
I have written about SPAC listings before, with the most comparable situation being Virgin Galactic Holdings, Inc. (SPCE). In February, I wrote an article called "Virgin Galactic Holdings: Early Cashless Redemption Provision On Warrants Could Cause A Stock Price Crash". SPCE has since dropped more than 50% in less than four months. While my reasons for being bearish on NKLA are different and far more pronounced, many of the mechanisms that saw SPCE crash in price exist for NKLA. SPCE was equally as hyped by momentum, short-term, day and rookie traders as NKLA is today, and its performance since its spike over $40 is as close as you can get to having a crystal ball or a time machine in the stock market.
The main reason why NKLA has had such an absurd ride, trading like a penny stock despite being valued in the multi-billions, is because its float available for trading is far lower than its total shares outstanding. A review of the May 8th prospectus shows that there are 23 million shares from the old VectoIQ shell that are currently in the float of the total of 360 million shares outstanding.
That is about to change as 52.5 million shares from the $525 million PIPE investment at $10 per share will be hitting the market upon registration of these shares. The company is required to register them within 45 calendar days of the business combination that took place at the start of June. That means it will occur no later than mid-July but it could happen sooner than that.
The borrow rates for shorting NKLA have gone through the roof, spiking as high as 400% or nearly a dollar per day per share. It's clear that PIPE holders are trying to find any shares they can borrow at any cost in order to lock in huge profits between their $10 investment and the current market price of the shares. They don't mind paying the high borrow fees because they know its only a matter of a few days or weeks before they can cover their short with their shares upon registration. They also know that over 50 million other shares are about to hit the market and they would rather guarantee a profit by shorting now rather than competing with those 50 million others trying to get out the door at the same time.
Options are derivatives that can be used to hedge or bet on the movement of a stock price. A call option allows the holder to buy the underlying stock at the stated strike price, while a put option allows the holder to sell at that price. Pictured below is a screen capture of options at a $64 strike price. Holders of these options are allowed to buy or sell a position of NKLA at $64 regardless of the stock's price at the time of expiry:
Source: Yahoo Finance
Under most circumstances, call and put options with short-dated expiries and strike prices that matches a stock's current price should be priced about the same. In the near term, it's equally as likely that a stock moves up as it moves down. This is not the case for NKLA options. The implied volatility for the put options is much higher than the call options, and greatly increases with time.
A put option expiring at the end of this week costs $11.62 but the same call option costs only $4.90. While the stock only has to move up 8% for the call option holder to break even, it has to drop 18% for the put option holder to break even. Options expiring on July 24 have an even greater discrepancy. Calls cost $8, so call option holders only need to see the stock move up 13% to break even. But put option holders need to see the stock drop to $30.86 or 52% just to break even. Put options have a maximum payout of $64 if the stock was to drop to zero, which it won't. The high cost of the puts despite limited upside shows how desperate and confident bears are that the price of NKLA shares will sink under $20.
Notice the variance in the pricing on put options with time. The July 2 and July 10 put options are both around $25, so traders don't value that extra week provided by the July 10 puts. But the July 24 put options are $8 higher at $33.14. I believe this spike in demand for that specific option is from the PIPE investors. Instead of shorting the stock, these PIPE investors are buying the put option knowing that their shares will be registered by then. They can use this option to lock in a price of $30.86 for their $10 shares.
There are 23.9 million Nikola warrants (NKLAW) outstanding from the VectoIQ shell. They expire in five years and have a strike price of $11.50 and thus have an intrinsic value of $52.50 based on a $64 stock price. However, they closed on Friday at a price of $23.02, nearly a $30 discount. This is because warrant holders cannot exercise their warrants yet, and there is a cashless exercise provision if the stock trades above $18.00 for 20 out of 30 days upon listing, which looks promising at this point. The warrants are supposed to be registered and become exercisable for cash within 15 business days after the completion of the business combination according to the warrant agreement. So we should see a filing shortly. Upon registration, arbitrage seekers would buy the warrants and sell the stock to quickly close the gap in intrinsic value and then collect on their arbitrage by exercising each warrant plus $11.50 in cash for each share.
The mechanism of the cashless exercise based on a VWAP to determine a fair market value is similar to the one I discussed on SPCE, with a similar end result of a cratering stock price expected if it is undertaken. For instance, if the fair market value ended up being $40, that would lead to the issuance of 17 million shares to expunge 23.9 million warrants based on cashless exercise. This is calculated as (40-11.5)/40 = 71.25%. The company would save marginally on dilution, but that would wreak havoc on the current 23 million share float. If the fair market value is $60, that percentage increases to 80% or 19.3 million shares issued to expunge the 23.9 million warrants. If the fair market value declines to $20, fewer shares would be issued but by then shorts would have already won.
Whether NKLA goes the route of cashless exercise and forces immediate exercise of a high percentage of the 23.9 million warrants or allows warrant holders to exercise all 23.9 million warrants at their own convenience over the next 5 years, selling pressure on the stock will occur.
NKLA stock has been pushed up in price to unsustainable levels as young and impatient traders chase it looking for the next Tesla (TSLA) without really understanding the mechanisms of NKLA's status as a SPAC listing. The float will triple and possibly quadruple upon registration of the PIPE shares at $10 and public warrants over the next few weeks. PIPE shareholders are so desperate to take profits that they have pushed up the borrow rate on NKLA shares to well above 100% and pushed up the price of late July put options to more than half of the stock price.
Traders in NKLA stock should expect a decline in the stock price leading up to the registration of PIPE shares and NKLAW warrants, and expect that decline to accelerate post-registration. There's a good reason why the mechanisms to hold bearish positions on this stock are so expensive. Hold this stock at your own peril. I expect to see the stock under $20 by the end of July.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in NKLA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may buy put options on NKLA in the near future.