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CTA Spotlight: Cervino Capital Management
June 9, 2008
We have spent a lot of time in this space, talking about the allure of option selling CTAs, and potential pitfalls which have hit them over the past 18 months as volatility spiked from all time lows. And through all of that, some option “trading” managers have unfairly been lumped in with the option “sellilng” managers – causing them to be tainted in a way. Well, we’re here to say all option trading managers are not option sellers, and don’t necessarily have to carry the stigma that comes with naked option selling.
This month’s CTA Spoltight is on an option “trading” manager, Cervino Capital Management.
Who is the Manager:
Straddling the border of Italy and Switzerland is Monte Cervino, probably the most famous mountain in the European Alps, also known as the Matterhorn. When Davide Accomazzo, who grew up in Italy, and Mack Frankfurter, whose father grew up in Switzerland, founded their CTA in 2005, the name best signified the kind of money management firm they wanted to build—independent and enduring.
Accomazzo and Frankfurter are veterans in the managed futures industry, and have established themselves as erudite practitioners through their “SSRN Top 10” academic working paper, “Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures” [http://ssrn.com/abstract=1029243].
Accomazzo began his financial career in 1996 at Jefferies & Co. trading Euro-convertible bonds/equities. In 1999 he started Kensington Offshore Ltd, a hedge fund, before launching Kensington Capital Management in 2001, a CTA he ran until 2004. He received a Laurea in Political Sciences and International Relations at Universita' degli Studi Genova in 1990, and his MBA in Finance at Pepperdine University in June 1996, where he now also serves as an adjunct professor to the Graziadio School of Business and Management.
Frankfurter first became involved in managed futures in 1991 when he joined The Echelon Group, which focused on investing with emerging managers and “incubated” several renowned CTAs including Dreiss Research, Jackson Grain and Range Wise. In fact, Frankfurter’s mentor is said to have been the first client of Richard Dennis who is famous for having trained the “turtles.” In addition, his experience encompasses the institutionalization of viatical settlements, and strategic consulting for various investment banks.
The pair met at UBS in 2005 in Los Angeles and quickly realized that the combination of their background and skills—Accomazzo is the principal trader and Frankfurter oversees operations—was a perfect fit.
Much of the partners’ focus nowadays is on their profession. That said, Accomazzo, who played competitive tennis as a teenager, makes sure to carve out time for physical activities such as tennis, surfing, skiing, etc. Frankfurter enjoys hiking whenever he gets a chance, and plans to get back into sailing and surfing.
How does the program work?
Cervino Capital’s Diversified Options Strategy is focused on providing ‘risk-adjusted returns,’ that elusive quality where positive returns are generated with minimal leverage and volatility, through the trading of options on stock index, currency, and bond futures.
The objective of the Diversified Options Strategy 1X program is to produce an absolute return between 10% and 15% annually, while the 2X version trades twice as many contracts as the 1X program for the same trading level (resulting in an increased potential for higher returns (20% to 30% annually) as well as an increased potential for larger drawdowns.
Cervino Capital’s philosophy recognizes that while mathematical techniques reveal important dynamics within the markets, circular relationships between cause and effect relegate quant models to just an abstraction of reality... ..meaning that expecting these models to be exactly right all of the time is unreasonable.
This viewpoint guides Accomazzo, whose trading considers multiple factors including global macro developments. He understands that investment performance is a function of risk taken, but also that the complexity of human behavior can never be fully modeled. Rather, a discretionary common sense approach is needed—one which balances the quantitative with the qualitative in order to manage the cycles of volatility.
Accomazzo thinks of option trading as a three-dimensional chess game. A major distinguishing feature of his approach is that he considers himself an “options trader,” not an “options writer.” The difference is realized in risk management strategies. Option writers tend to rely on the probability of whether or not an option is going to go into-the-money or not, while an active option trading style recognizes the need to manage the possibility of risk-of-ruin when under extreme circumstances.
A good example of this active management took place on February 27, 2007, when the DJIA dropped 300 points in 30 seconds due to a technical glitch. Rather than suffering the “deer in the headlights” syndrome, Accomazzo covered half his naked put positions that day, and covered the remaining at risk put options the following day.
2007 was generally a very difficult year for option programs due to the transition from low volatility to high volatility. The risks associated with option writing during the 2003-2006 volatility bear/stock market bull was generally misunderstood at the time. On the other hand, Cervino Capital’s concern was documented in a January 2007 article Frankfurter wrote called, “The Mysterious Case of Massive Liquidity.”
For Accomazzo, trading is all about historical perspective, homework, risk management and discipline. He is continuously processing large amounts of seemingly disconnected information, including fundamental, technical, quantitative and behavioral analysis, in order to arrive at a decision, which often is to not put on a trade. Having traded during the 1998 LTCM meltdown, 9/11 WTC attack, as well as the recent credit crisis, Accomazzo has the wisdom to know that trading is not about hot returns, but consistent returns.
Debit spread: long 2 Sep. S&P 1250 puts / short 2 Sep. S&P 1240 puts
Entry price = $1.60; Price on 5/30 = $1.40
Credit spread: short 1 Jun. S&P 1300 puts / long 1 Jun. S&P 1290 puts
Entry price = $0.85, Price on 5/30 = $0.40
Naked option: short 2 Jun. S&P 1190 puts
Entry price = 8.10 (resulted from lifting the long leg of an earlier debit spread); Price on 5/30 = $0.30
This is an example of the kind of complex option position that Cervino Capital trades. The debit spread “reinsures” the credit spread which is intended to capture premium as time decay accelerates. Each of these spreads have “defined” risk with the short option position “financing” the long option position in the credit spread. The different calendar dates encompasses a diagonal spread option trading technique. The robust nature of the option construct helps to mitigate equity volatility and allows opportunities to “transform” positions as may be required due to extreme volatility in the underlying S&P Index.
Cervino Diversified does trade other markets besides the S&P 500, such as bonds, currencies, and Gold.
You don’t usually hear the terms “option selling” and “risk averse” in the same sentence, but Cervino Capital appears to be the exception to that rule (especially when compared with other CTAs in the "Option selling" sub category)y. Perhaps that is because they do not only sell options, but hedge against volatility spikes as well.
While there are no guarantees in investing - there are techniques for limiting risk exposure such as reduced margin use, hedging via long options, and diversifying across multiple lowly correlated markets. Cervino engages in each of the above risk limiting techniques on a regular basis, and in turn has outperformed its option trading peers during a very tough period for option sellers the past 18 months.
While many option sellers were hitting new all time drawdowns, and seeing monthly losses well past their historical DDs, Cervino had a very manageable dip, and came out of it nicely, returning +16.65% over the past 12 months with 11 out of 12 months profitable on their 1x strategy. In addition, they show a very low correlation with the S&P 500 (0.0613), and have a Sharpe ratio among the top 10% of all CTAs in our database.
Despite all these positives, Cervino was having trouble getting investor interest. This is due to two factors in our opinion. One, they were a little unfairly labeled an option seller and thrown in with the others who only do naked short options. Those at Cervino view themselves as “option traders”, not “option sellers”, and don’t strictly sell naked options.
And two, their annual rates of return weren’t too exciting if you looked just at the absolute numbers, and not on a risk adjusted basis. For example, on a risk adjusted basis, an annual return of 30% with a 15% DD is the same thing as an annual return of 10% with a 5% DD, but investors usually pick the higher return investment because of the higher absolute number (30 > 10).
To combat this and appeal to those investors who prefer higher return and risk numbers, Cervino launched its 2x strategy as of Jan. 1, 2008. The 2x strategy has the same trading parameters as the 1x strategy, and will do twice the number of positions as the main program on the same $50,000. Or trade the same number of positions as the main program, but require only $25,000 in capital. The result will be performance and risk twice that of their main program. So far in 2008, the 2x program is up approximately 12% (versus roughly 6% for the main program)
In fact, the 2x program will do better than two times the main program for a limited time, due to Cervino only charging a 2% management fee on the 2x strategy, as opposed to 2x their normal 1.5% management fee (3%).
Mack Frankfurter of Cervino is one of those managers who loves talking with clients, and answering any questions they have, and we encourage people to call him up, ask him his thoughts on Cervino, on whether there is a commodity bubble, or anything else. He’s happy to swap ideas. For quarterly updates on Cervino you can also visit the manger’s Blog at http://cervinocapital.blogspot.com/.
IMPORTANT RISK DISCLOSURE
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Feature | Week In Review: Crude sees unbelievable $17 spike in 2 days, stocks slide | Chart of the Week
The energy sector came to the forefront again last week as geopolitical tensions and continued worries that demand will continue to outpace production sent energy prices soaring (up $17 in just two days) Natural Gas also found added support from ideas usage would ramp up due to warmer temps in the U.S. The leader for the sector this week was the Crude Oil posting gains of +8.18%, although Heating Oil and Natural Gas were not far behind with increases of +7.84% and +7.80%. The laggard if you will was RBOB gas with gains of +5.74% as larger than expected weekly stocks held it back a bit.
As you might expect with the largest spike in energy prices since the first Gulf War, U.S. equity markets took it on the chin, especially late week due to the worst monthly jobs report since 1986. The bad figures coupled with the surge in energy prices, brought the recession talk out of the closet again setting up a very important upcoming week with a barrage of inflationary reports due out. For the week Dow futures lost -3.45%, SP futures were down -2.94%, and NASDAQ futures shed -2.39%. The small-cap sector also posted loses, but not as severe with the Russell down -1.28% and the Mid-Cap losing -1.24%.
Currency and bond trading remained in the slow lane last week, although an early attempt at an upside breakout by the U.S. Dollar was thwarted by the bad news from the monthly jobs data. The surge by the energy sector also seemed to scare the bid from the U.S. Dollar as it finished the week a touch lower -.73% against most continentals. Euro Currency +1.52% and Swiss Franc +2.30% found added support from the hawkish attitude from the EU central bank stating they would take necessary measure to curb ongoing inflationary pressure in Europe. In bond trading the benchmark US 10 Year Note futures finished the week +1.75%, and the US 30 Year Bond futures were up +.96% as flight to quality buying due to the break in the stock indices was seen as the main feature.
The Soft commodity sector found upside momentum from the energy rally, although bad weather in the U.S. Midwest also contributed to gains as worries of planting and emergence issues spark a strong rally in the grains. Corn 7.92% was the leader, but Soybeans +6.55% and Wheat +6.21% were not far behind. The livestock fell victim to the rally in grains and heavier than expected production as Lean Hogs lost -4.89% with Live Cattle down -1.73%. In other food sectors OJ futures gained +7.57% and Cocoa was up 4.25% on news of possible crop problems.
For many Index Option Selling mangers; last week (especially Friday) represented the first true test of the 2nd quarter as the VIX or Volatility Index as measured by the CBOE rocketed up over 26% in one day. It is no surprise that this one day increase resulted in most Index option managers moving into the red to start June. Ace Investments was the hardest hit by the move as they typically trade with higher margins closer to the market, they are down approximately -3.74% to start the month. One exception to the to negative move was Ascendant Strategic 1 which is ahead approximately 2% to start the month.
Other option selling returns for the MTD include the following: Zephyr Aggressive -2.35%, LJM Partners -1.58%, Zenith Index -1.44%, Zenith Diversified -1.05%, Rathiel -0.91%, Cervino DOS 1x -0.23%, Cervino DOS 2X -0.64%, and FCI -0.16%. As noted above in the "Featured Article" we expect that Cervino's drawdowns on one day volatility spikes will typically be lower as a function of smaller margin, hedged positioning, and market diversification - past performance is not necessarily indicative of future results.
With the growing season in full swing and a wild range of weather patters across the US it is no surprise that we've seen some activity in Agriculture CTA's. To start the month the NDX Shadrach and Abednego strategies are shinning stars with estimated returns of +9.65% and +4.48%. Through May Shadrach is ahead +12.47% YTD and Abednego is ahead +3.15%. Others in the Agriculture space include Rosetta up aprox 1% and Chicago Capital -1.2%.
Among multi-market managers thus far in June, they can be separated into two categories; those that are long energies and making money and those that are not. After one week of trading the Attain Portfolio Advisors Modified Program is the top performing multi-market CTA. The modified program, which is an offshoot of the original $1MM program, is up approximately 6% so far this month. Long positions in emini crude oil along with emini natural gas have provided most of the gains; although short positions in the softs and several profitable trades from the day trading models have helped as well. The APA Strategic Diversification Program which holds slightly different positions than the modified is up an estimated +1.50% in June so far.
Next in line for the multi-market traders is the Longterm Trading Navigator Program which is up +1.42% this month. The manager has seen profitable trades in the energies, grains, and softs already this month and is looking to post profits for the third straight month. The Dighton USA Swiss Futures Program is the only other multi-market manager in the black so far in June with returns of approximately +0.72% and has open positions in Coffee and Cotton.
A week after stating that futures markets had entered the doldrums of summer, trading activity dramatically increased due to the aforementioned factors (oil prices, US employment, etc…) and put that theory on hold for a while. With equities plunging between 2 and 3 % on Friday alone, several day trading systems were able to finish the week well into the black while swing systems had mixed results depending on their bias to equity and bond markets.
Beginning with the day trading systems, Compass SP hit new all-time equity highs after adding +$7,603.55 on five trades for the week. The bulk of that performance came from two trades on Thursday and Friday, one long and one short respectively. Rayo Plus Dax benefited from the tumbling of the German Dax late in the week and took in +$7,577 on three trades for the week. BetaCon 4/1 ESX was +$944.50 on three trades in the lesser valued Eurostoxx contract (10€ per point vs. 25€ in the Dax). Waugh eRL lost -$466 on five trades for the week.
Moving on to the swing systems, Signum EBL was the top performer for the week after adding +$4,278 in open and closed trade equity. The program was holding short two Eurex Bund contracts and reached its first profit objective late in the week. The Jaws Bond systems found success last week with the US 400 program +$718.75 and the US 60 +201.85. Both programs went short at various times throughout the week but exited prior to Friday’s employment report which sent the US treasuries sharply higher. Tzar exited its short ERL trade for a loss of -$3,770 while the NQ continues to hold short and the ES continues to hold long. Ultramini ES went long on Friday and was stopped out for a loss of -$567.50.
Finally, long term systems were fairly quiet despite the huge run-up in energies and metals. Most trend-following system have generated long signals in Crude, Natural Gas, etc… but the risk on the trades have exceeded the customer risk profiles. If soft commodities continue to move lower, look for new entries in Sugar, Cotton, Coffee, etc… in the coming weeks.
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.