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CTA Spotlight: Crescent Bay Capital Management
May 5, 2008
As a follow-up to our last two newsletters, one on the tough environment option selling CTAs have survived through in the past year, and one on the rise in global volatility – a logical choice for a CTA spotlight this month was an option selling CTA which has not only survived the poor option selling environment, but also profited from it with a new hybrid volatility program. This month’s CTA spotlight is on Crescent Bay Capital Management, and their two programs: the Premium Stock Index and Balanced Volatility programs.
Who is the Manager:
The manager of Crescent Bay Capital is Mr. David Bedford, who lives in Southern California about 10 miles away from the actual body of water named Crescent Bay, in Laguna Beach.
While we’ve seen managers range from former Philosophy majors to high school teachers, we’ve never seen anyone take the path David took into becoming a registered Commodity trading Advisor.
Mr. Bedford’s path into the managed futures industry has been modest, methodical, and almost entirely self-directed. He graduated from Pepperdine University in Malibu (one of the prettiest campuses you’ll ever see), then went from wood flooring sales to a Biomaterials Research Associate, before finally landing in dental product sales.
But the research associate position at the University of California San Francisco opened his eyes to the world of statistical and quantitative testing methods, and in 1999 David began trading on his own. He credits wisely holding on to his “day job” in dental products sales with his success, as it provided him with the income and flexibility to research numerous trading strategies and markets without immediate financial pressure to perform. This patience and evolution of learning led to the founding of Crescent Bay Capital Management, Inc. in 2003 and a not-so-sad goodbye to the day job in 2006.
Outside of running the CTA, David reports he is “blessed with a loving and supportive wife of 15 years and two daughters, ages 6 and 4". And like most Californians, David enjoys almost any outdoor activity in his free time that is safe from the glow of computer screens… fly fishing, kayaking, and surfing, just to name a few.
How do the Programs Work?
Crescent Bay has two main programs, 1) Premium Stock Index and 2) Balanced Volatility; which seemingly don’t seem like they could be run by the same manager.
That is because the newest of his programs, the Balanced Volatility, is actually set up to offset volatility risks. That sounds an awful lot like the program is actually long volatility at times….which seems counterintuitive coming from an option selling (short volatility) manager.
Balanced Volatility Program
Crescent Bay’s newest offering the “Balanced Volatility Program” (BVP) is a unique option selling hybrid. The program takes the best of the Premium Stock Index program and incorporates additional risk prevention by buying options with further out expiration, in hopes of offsetting volatility with slower time decay.
These long option positions are designed to create stability when volatility rises. It is well documented that selling premium (short options) is profitable in quiet or low volatility markets, however, when volatility increases sharply, months' or even years' of profit can be lost if risk is not properly managed.
The strategies used in the BVP are a blend of options and futures contracts used to create positions that are buffered from the previously discussed increases in volatility. More specifically, the BVP strategy trades three different positions simultaneously to achieve its goal.
* The first position sells options
* The second position buys options
* The third position buys the underlying futures.
These three positions are placed using proprietary strike levels and ratios to achieve a strategy that can achieve profits in flat or volatile market conditions.
Premium Stock Index Program
But at the heart of things, Crescent Bay is an option selling manager focused on capturing the time decay inherent in options by shorting volatility. In Mr. Bedford’s words: “Crescent Bay Capital is an educated seller of insurance to other market participants looking to buy insurance on their stock market exposure”
This “pure option” selling, for lack of a better term, is what drives the Premium Stock Index program. Out of the money options are sold with about 30 to 45 days until expiration. But unlike many managers who then wait for those options to expire worthless, Crescent Bay uses what it calls an “opportunity cost profit stop” to trigger exits. This profit stop is based on the logic that underlying futures moves can accelerate the profit potential of the position. For example, if an option is sold 40 days out from the expiration date and a market move occurs which results in a 70% profit after only 5 days, the position would be covered and the profit realized. This allows for the sale of a new option (still 35 days out from expiration) and the opportunity for increased returns, rather than waiting 35 days to capture the remaining 30% of the initial premium.
What makes both strategies unique is that historical prices are not used to establish positions. Many option selling methods are based on the assumption that historical price data can predict future prices, but Crescent Bay believes looking only at past prices can fool you and result in deeper drawdowns and lower accuracy.
Finally, both programs combine algorithmic calculations (systematic) and Mr. Bedford’s own market experience or “touch” (discretionary) in a ratio of about 70% systematic and 30% discretionary to pick out not just where to sell options, but also when.
The combination of these two elements is best exemplified by Crescent bay’s use of a proprietary model (systematic) for trend identification, which has many times caused the manager Mr. Bedford (discretionary) to side-step selling options just before a large increase in volatility (which can be the Achilles heel of option selling).
Mr. Bedford does not pretend to call the market’s every turn, however, and his humble acceptance of the unknown factors which move markets are largely what led him into the development of premium selling strategies. As he likes to say, “I don’t have to be right, I just have to avoid being really, really, really wrong.”
As seen in our newsletter two weeks ago (Option Selling CTAs: 13 months after the Volatility Spike), Crescent Bay’s Premium Stock Index program, which is short volatility, navigated the increased volatility quite well and has been on of the top option selling programs over that time. But the more interesting item may be Crescent Bay’s Balanced Volatility program.
This is because there are a lot of option selling programs out there which are statistically pretty correlated with the Premium Stock Index program. But there aren’t a lot of programs out there which are attempting to blend some long volatility elements into their strategy as the Balanced Volatility program is doing. And that makes the Balanced Volatility program more interesting, at the very least; and possibly more deserving of a look to invest in. This is especially true if you have some exposure to an option selling CTA already. Why not hedge your bets a little bit and add a program which is designed to protect from a volatility spike?
The problem with a hedge, always, is the cost. Nobody likes paying for insurance. But the Balanced Volatility, with its minimum investment amount of just $10,000 helps out in the cost department a little. Their minimums are so low because the execute exclusively in the e-mini SP options and futures.
However, as your grandmother may have told you - good things don’t last forever. And Crescent Bay is actually raising their minimum investment amount from $10k to $25k on July 1st. As you probably know, when CTAs become more successful, they are prone to raising their minimums in order to maintain the consistency of performance to their existing and future clients. If you believe that the markets are going to remain volatile for the foreseeable future, now might be a good time to dip your toe in the water before the minimums are raised.
IMPORTANT RISK DISCLOSURE
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Last month saw the energy sector post the strongest grains of any commodity sector as production problems in Nigeria and the North Sea due to geo-political events attracted risk premium buyers. Heating Oil and Natural Gas also found support from unseasonable cooler temps in most of the U.S. during the month. The largest advance was in Crude +10.9% itself, but Heating Oil +9.6%, RBOB +9.8%, and Natural with gains +6.1% were not far behind.
Stocks finished April in a fairly happy atmosphere as the ebbing of the credit crunch and better quarterly earnings results attracted investor money out of fixed income in to the equity sector. The SP 500 futures gained +4.5% and Dow Jones futures were up +4.3% to break a multi-month losing streak. The Tech sector added gains from the previous month as NASDAQ futures finished the month with gains of +6.9%. In small-cap trading the Russell 2000 futures were up +3.8% while SP Midcap 400 futures added 6.9%.
Treasury futures posted losses across the board as added pressure on ideas the most recent cut in rates by the FOMC could be the last for the foreseeable future sparked losses in both the bench mark 10 year note -2.5%, and 30 year bond futures -2.6%. Finally in currency trading the Dollar seemed to find a bit of a bid, albeit small ending +0.9% for the month while Eurocurrency futures fell -0.8%. The Swiss Franc -3.9%, and Japanese Yen -4.2% found pressure on worries of that inflation might garner further strength in the months to come.
Ag commodities posted gains for the most part last month with turmoil and weather being the catalyst for gains. Soybeans +7.5% found support on farmer blockades in Argentina and along with Corn +5.1% experienced added weather risk premium. The livestock sector posted strong gains on foreign demand with Lean Hogs adding +7.6% and Live Cattle +6.2%. Wheat futures fell -14.5% and Cotton -2.5% with ideas of larger production and in the case of cotton plentiful supplies sparking pressure.
The softs posted decent gains in April with Cocoa +16.6% on weather problems as the prevailing story. Orange Juice +5.9% and Coffee +4.5% also found support on a lack of producers selling and rumors the Brazilian government was in planning stages to evenly distribute these crops over the year a not have supply flood the market during harvest.
As discussed in several of our past newsletters, including the main topic from April 21st (http://www.attaincapital.com/newsletters/276), option selling strategies have the potential to perform well in higher volatility markets as long as they survive the initial shock. April was one of those months where most of the option sellers we track were able to capitalize in both the stock indices and Commodity Option markets following the "Bear Stearns" market shock in March. Of the Stock Index Option mangers, Ace Investment Strategist was the top performer with estimated returns of +5.68% in April. Following the January market shock Ace is now at break even for the year and ahead +24% over the past 12 months.
Other index option manager estimates for April were as follows: Ascendant S1 +5.1%, Cervino Diversified 2x +2.39%, Zephyr Aggressive +1.71%, Zenith Diversified +1.14%, Cervino Diversified 1x +1.04%, Crescent Bay BVP +0.96%, Diamond Capital +0.87%, Crescent Bay PSI +0.74%, Zenith Index +0.56%, Zephyr Moderate -0.93%.
In Commodity option trading FCI has had an excellent year thus far and was able to extend its run by adding an additional +3.31% in April. FCI is now ahead an estimated +8.6% for 2008 YTD and is approximately 3.6% away from a new equity high.
Agriculture mangers had mixed returns for April yet continue to remain strong portfolio components for the year. On the whole, of the mangers we track the average YTD return have been +8.2%. The top performer for April was NDX Shadrach which earned an estimated 3% and is up 12.9% YTD. Shadrach's less aggressive counter part, NDX Abednego, was ahead +0.75% and is up 3.02% YTD. Rosetta lost an estimated -3.25% yet remains ahead +20.45% YTD. Finally, Chicago Capital lost -0.61% in April and is down - 3.56% YTD.
Multi-Market & Trend following CTA performance was mixed in April as trading became very choppy across most commodity markets. Energies were especially volatile with crude oil futures falling -5.50% in the last two trading days of the month. Plus, a late rally in the treasury futures markets and dollar index, made profits very hard to come by for those with short positions.
Just as trend followers began to struggle, Dighton Capital showed off its counter trend logic with gains of +11.50% in April. Trading highlights included adding to a long position in the Dollar Index as the Dollar pulled off its lows in intra-month trading.
Other profitable multi-market CTA’s in April included the Longtermtrading.com’s Navigator program which had estimated returns of +5.10%. Longterm posted two very nice trades in the energy complex during April. The Optimus Capital Diversified program was next in line with returns of +2.49%. Optimus closed out multiple winning trades in the e-mini stock indexes, FX futures and treasury futures markets throughout the month. The Vision Capital Global program also posted positive returns of +1.93%, although the manager is still in a significant drawdown after losing -18.12% in March. The Hoffman Asset program also returned to profitability with returns of +0.90% in April.
On the downside, the Attain Portfolio Advisors Strategic Diversification program had a rough month in April losing -4.44%. The APA modified program also struggled and lost -4.60%. The losses were mainly due to trades in their intermediate term, swing trading models; which had trouble finding the right low risk entry spots in several markets including stock indexes, bonds, meats, grains, & energies.
Also finishing the month in the red was Robinson Langley Capital which lost -4.99% and Northside Trading at -2.74%. Both of these programs are newer to Attain and will be watched closely as commodity market volatility remains historically high.
A sharp reversal in equities and the corresponding move lower in bond markets paved the way for profits across the majority of the swing trading systems in April and a handful of day trading systems. Volatility has trailed off as equities continue to rebound off their March lows, but still remains well above their five and ten year averages.
Starting with the swing systems, Signum EBL made an astonishing +$7,470 after reaching its profit objective on one of the two contracts it was holding short. The system has been holding short since late March and is positioned well to lock in gains if the Bund rebounds from its recent lows. Tzar ES was second only to Signum with profits of +$3,040 for the month after reversing long near the lows and then reversing short late in the month to lock in the gains. Mesa Notes was holding short in the Ten Year for the majority of the month and profited +$2,621.87 in open and closed equity. The system is currently holding long and losing ~ $1K in open trade equity. Bounce eRL caught the initial rebound in April as investors moved money back into equities and profited +$2,130 on one single trade that it held for a few days.
Ultramini ES came through in April with profits of +$1,135.39 on three trades. Jaws US 60 had three trades as well for profits of +$538.70. SeasonalST was slightly profitable with gains of +$165 on two trades for the month. Tzar NQ and eRL were in the red by -$43.54 and -$1,324.64.
Moving on to the day trading systems, AK 47 ES was the top performer with profits of +$2,197.50 on three trades for the month. Close behind was BounceMOC eRL with profits of +$1,445.91 on one trade. BetaCon 4/1 ESX had a breakout month with profits of +$1,135.39 on seven trades for the month while Kappa 12/1 Dax was much more active with thirteen trades good for profits of +$203.58.
Compass SP struggled in the month of April with losses of -$2,500 and Rayo Plus had similar struggles with monthly losses totaling -$3,535.16.
For long term systems, the aforementioned rebound in equities and decline in global bond markets signaled exits and some new entries late in the month. Aberration Plus exited a long position in the Ten Year Note for a gain of +$8,797 on multiple legs of the trade. Towards the end of the month, further declines in global bond markets signaled new short entries, including a new short position for Aberration Plus in Eurex Bund.
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.
Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.
Please read carefully the CFTC required disclaimer regarding hypothetical results below.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.