SPAC Arbitrage Explained: Buying Trust-Backed Shells at a Discount

The thesis: a trust account with optionality attached

A Special Purpose Acquisition Company (SPAC) is a shell company that raises capital through an IPO, parks the proceeds in a trust account, and spends 18–24 months searching for a private operating company to acquire (the “deSPAC” merger). When public investors buy a SPAC IPO unit at $10, that $10 (plus a small overfunding) goes straight into a trust account that holds short-duration US Treasuries.

Crucially, every public SPAC shareholder has a redemption right: when the SPAC announces a target and puts the deal to a shareholder vote, holders can elect to redeem their shares at the trust value (roughly $10 plus accrued Treasury interest) regardless of how they vote on the deal itself. This combination of features — cash-equivalent floor plus optionality on a deal — is what makes pre-deSPAC SPACs an arbitrage instrument.

If you can buy SPAC shares at, say, $9.85 when the trust holds $10.10 of Treasuries per share, you are buying a near-riskless 2.5% carry plus a free call option on the eventual deSPAC announcement. That is the trade.

Academic basis: structural costs and how returns split

The most influential recent academic work on SPACs is Klausner, Ohlrogge, and Ruan (2022), “A Sober Look at SPACs,” in the Yale Journal on Regulation. The authors meticulously documented the structural costs embedded in SPACs — sponsor promote shares (typically 20% of post-IPO equity, granted to the sponsor for a nominal sum), warrant overhang issued to IPO buyers, and underwriting fees — and showed that by the time of the deSPAC merger, the median SPAC delivers only about $6.67 in net cash per share to the merged company despite raising $10 per share. The remaining $3.33 is dilution that hits whoever is left holding the merged stock post-vote.

The implication: holding through the deSPAC vote is a losing trade on average. The Klausner-Ohlrogge-Ruan analysis covered SPACs that completed mergers in 2019–2020 and showed median post-deSPAC returns of approximately -12% in the three months after the merger and significantly worse over twelve months. Holding pre-vote and redeeming for cash is economically rational; holding through the vote is not.

Gahng, Ritter, and Zhang (2023), “SPACs,” in The Review of Financial Studies, decomposed SPAC returns by investor type. Pre-deSPAC SPAC arbitrageurs (often hedge funds buying at IPO and redeeming or selling at deal) earned approximately 9.3% annualized on a riskless-equivalent basis from 2010–2021. Post-deSPAC public shareholders earned dramatically negative returns over the same period. The authors framed SPACs as a wealth transfer from post-deSPAC retail holders to pre-deSPAC arbitrageurs and sponsors.

This decomposition is what defines the arbitrage opportunity: the strategy works precisely because it captures the trust-account carry plus optionality without taking on the post-merger holding-period risk that destroys the average SPAC investor.

Trust-value mechanics: where the discount comes from

SPACs typically IPO at $10.00 per share. In recent years, sponsors have increasingly overfunded trust accounts to $10.10 or even $10.20 per share to make the IPO more attractive to institutional buyers. The trust holds short-duration Treasuries (usually 3-month T-bills) which earn the risk-free rate. Over a typical 18-month SPAC life span at a 5% annualized short rate, that is approximately 7.5% additional accrued interest per share.

So a 12-month-old SPAC with $10.10 initial trust funding and a 5% short rate now holds roughly:

10.10 + (10.10 × 0.05 × 12/12) = $10.61 per share

If that SPAC is trading at $10.05, the discount-to-trust is roughly 5.6%. Holding to redemption captures that gap. The annualized yield depends on how soon the redemption occurs — either at deal-vote completion (capture the full discount) or at trust-deadline expiration (capture trust value if no deal materializes).

So why do discounts exist at all? Three reasons:

• Capital cost: holding SPACs ties up capital for unknown but bounded periods. Investors who can deploy capital more productively elsewhere demand a yield premium.
• Extension risk: SPAC sponsors can request shareholder approval to extend the trust deadline, sometimes funding the extension by drawing trust funds (haircutting per-share trust value). Pre-extension SPACs trade at slightly wider discounts in anticipation.
• Liquidity premium: most SPACs trade thinly, so even small institutional positions move the market. Patient buyers earn a few extra basis points for waiting.

Lewellen (2009), “SPACs as an Asset Class,” established the theoretical framing for SPACs as fixed-income-like instruments with embedded equity options — a frame that subsequent literature has built on extensively.

Risks: extension, sponsor warrants, and deadline brinkmanship

SPAC arbitrage is not entirely risk-free, even with the trust-account floor:

Extension dilution. When the original deadline approaches without a deal, sponsors often propose extensions of 3–6 months. Extensions are funded by either (a) sponsor cash contributions back into trust (positive for holders) or (b) a partial trust haircut where redeeming holders are paid out and remaining holders see slightly less per-share trust value. Dimitrova (2017), “Perverse Incentives of SPACs,” examined how sponsor incentive structures — the 20% promote shares only become valuable if a deal closes — can lead to deal-or-die behavior at the deadline that destroys post-deSPAC value.

Sponsor warrant overhang. SPACs commonly issue warrants alongside IPO units giving public buyers the right to buy more shares at $11.50 post-merger. While this doesn’t affect the trust-arbitrage trade directly, the warrant strike acts as a soft cap on post-deSPAC stock prices and influences how arbitrageurs value the embedded optionality.

Deadline brinkmanship. If a SPAC fails to close a deal by its deadline (and after permitted extensions), it must liquidate and return trust value to shareholders. This is generally good for arbitrageurs — you collect the trust value — but the timing of liquidation can be uncertain and there is a small administrative cost to the unwinding.

Lakicevic and Vulanovic (2013), “A Story on SPACs,” examined SPAC announcement returns and showed that target-quality signals at announcement are mostly unreliable in advance — another reason to redeem rather than hold post-vote.

The deSPAC inflection: why this is a pre-vote strategy

Every academic study of SPAC returns reaches the same conclusion: the arbitrage works pre-vote; holding through the vote does not. This is not subtle. Cumming, Hass, and Schweizer (2014), studying SPAC IPOs in the 2003–2008 cohort, documented similar patterns in Europe. Modern post-2015 US SPAC data tells the same story with even larger magnitudes.

The arbitrage strategy has a clean exit rule:

• Buy SPAC shares trading below trust value
• Hold to deSPAC vote announcement
• Redeem for trust value if a deal is announced (regardless of whether you support the deal)
• Or sell into the secondary market if the share price rises above trust on deal speculation
• Either way, exit before the merger closes — do not hold the post-deSPAC entity

How Alpha Suite implements it

Alpha Suite’s SPAC arbitrage engine identifies SPACs by name pattern (“Acquisition Corp,” “Capital Corp,” etc.) and recent SEC S-1 filings. For each candidate, it estimates trust value as $10.10 plus accrued Treasury interest from the IPO date, computes the discount-to-trust against the current price, annualizes the yield, and ranks accordingly. Filters exclude pre-deal SPACs trading meaningfully above trust (where the optionality has already been priced in) and SPACs trading well below trust (where something is structurally wrong).

The signal includes the estimated trust value, the discount percentage, the deadline window, and the IPO date for context. See the strategy hub page for the full implementation details.

References

1. Cumming, D., Hass, L. H. & Schweizer, D. (2014). “The Fast Track IPO — Success Factors for Taking Firms Public with SPACs.” Journal of Banking & Finance, 47, 198–213.
2. Dimitrova, L. (2017). “Perverse Incentives of Special Purpose Acquisition Companies, the ‘Poor Man’s Private Equity Funds’.” Journal of Accounting and Economics, 63(1), 99–120.
3. Gahng, M., Ritter, J. R. & Zhang, D. (2023). “SPACs.” The Review of Financial Studies, 36(9), 3463–3501.
4. Jenkinson, T. & Sousa, M. (2011). “Why SPAC Investors Should Listen to the Market.” Journal of Applied Finance, 21(2), 38–57.
5. Klausner, M., Ohlrogge, M. & Ruan, E. (2022). “A Sober Look at SPACs.” Yale Journal on Regulation, 39, 228–303.
6. Lakicevic, M. & Vulanovic, M. (2013). “A Story on SPACs.” Managerial Finance, 39(4), 384–403.
7. Lewellen, S. (2009). “SPACs as an Asset Class.” Working Paper, Yale School of Management.
8. Rodrigues, U. & Stegemoller, M. (2014). “What All-Cash Companies Tell Us About IPOs and Acquisitions.” Journal of Corporate Finance, 29, 111–121.
9. U.S. Securities and Exchange Commission. (2021). Investor Bulletin: SPAC Investing. Office of Investor Education and Advocacy.
10. U.S. Securities and Exchange Commission. (2022). Special Purpose Acquisition Companies, Shell Companies, and Projections; Proposed Rule. Release Nos. 33-11048; 34-94546.