What Are Units and How Do They Work in the Stock Market?

Wall Street is home to all types of securities and strategies that traders can use to make some extra cash.

One of the lesser-common securities is the unit, which offers traders some flexibility down the road to capitalize on good market conditions.

Below, we are going to talk about units and why companies offer them – and why and how traders use units.

What is a unit?

A unit is a security that is made up of one common share and half a warrant.

Units are commonly offered by special-purpose acquisition companies, or SPACs that are seeking to raise money in a public stock offering and trade on a stock exchange with the primary goal of merging with a private business and taking it public.

Meaning of stock warrants

Stock warrants are almost similar to stock options in that they give the holder the right to buy (via a call warrant) or sell (via a put warrant) shares of a company at a pre-agreed price (strike price), before a certain date (expiration date).

Warrants are issued by a company and may serve a vital role, making a potentially lackluster offering more appealing by giving a bigger upside to buyers.

If the price of a stock moves above the strike price, the holder of the warrant can buy shares at a price lower than the market.

Generally, the value of warrants increases and decreases in the same direction as the price of the shares they are associated with.

For example, a pharmaceutical company might sell common stock to fund the development of a drug. At the same time, the company will often offer warrants free to individuals that buy the stock.

Once the drug is developed and is found to be economically viable, the value of the shares and warrants of the pharmaceutical company will go up.

Simply put, the owner of the warrant receives a financial kicker for choosing to purchase common stock during a risky phase.

While warrants are good for a fixed period of time, they are worthless once they expire. Most warrants have a maturity of one to two years, though they can last 10 years.

How units work

As stated above, units consist of common stock and warrants and give the owner the right to rack up more shares at a later date.

Typically, when a blank-check company goes through the IPO process, it prices its units at $10 apiece. However, those units are often only available at that price to large institutional investors and the sponsors on the deal.

After the SPAC has announced a merger, its sponsors can choose to redeem their shares for the per-share amount ($10) that is being held in the SPAC’s trust account before it closes the merger.

Therefore, the risk is less for those earliest investors. However, when a SPAC rallies in secondary trading, this may dramatically hurt the individuals who got in late

SPAC units

A SPAC is a blank-check company formed by investors with the sole intent of raising money on the stock market to eventually merge with a private business and take it public.

Investors who put money in a SPAC have no idea what company the SPAC will target when it makes its public debut and trades on a stock exchange.

However, a blank-check company may state in its IPO paperwork a specific business or industry that it will target as it looks to merge with an operating company.

In other words, if you invest in a blank-check company at its IPO stage, you are putting your trust in the management team or sponsors that created the company.

Digital World Acquisition Units

In recent days, Digital World Acquisition Corp (NASDAQ: DWAC) has been in the headlines as Wall Street traders race to bet on former President Donald Trump’s next move.

Shares of the special-purpose acquisition company have skyrocketed on news it will merge with Trump’s social media outlet known as TRUTH Social. DWAC intends to take TRUTH Social public by merging with Trump Media & Technology Group.

TRUTH Social is looking to compete with the likes of Twitter (NYSE: TWTR) and Facebook (NASDAQ: FB) by developing a platform for Trump supporters ahead of a potential 2024 presidential run.

TMTG has been awarded an initial enterprise value of $875 million as per its merger agreement with Digital World Acquisition.

Digital World Acquisition shares of Class A common stock trade on the Nasdaq under the symbols “DWAC” while warrants that are separated trade under “DWACW.” The unseparated units continue to trade on the Nasdaq under the “DWACU” symbol.

If you own unseparated Digital World Acquisition units, you need to have your broker get in touch with the SPAC in order to separate the units into shares of Class A common stock and warrants.

Digital World Acquisition stock recently surged from around $10 to reach a peak of $175 before dropping to the current $58.55 mark.

According to data from S&P Global Market Intelligence, Digital World Acquisition shares rose 580.9% in October.

Bottom Line

Digital World Acquisition has no assets or operations but has managed to raise a big pile of cash from investors by partnering with Trump.

Hedge funds who jumped on the bandwagon early are also probably sitting on hundreds of millions in profits.

The sponsors of the SPAC convinced these early investors that if they paid $10 apiece for 2.1 million Digital World Acquisition units, they could redeem the shares later for roughly $10.20.

Additionally, they were told they could keep the warrants, which could make them lots of cash if the stock performs well.

But as the U.S. Securities and Exchange Commission (SEC) warns on its website, the IPO price of a SPAC is not based on a valuation of an existing business contrary to the traditional IPO of an operating company.

According to the regulator, the market prices of units, common stock, and warrants may fluctuate when they begin trading, and these fluctuations may bear little relationship to the ultimate economic success of the SPAC.