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Managed Futures Spotlight: Emil Van Essen Spread Trading
July 27, 2009
We have highlighted trend following commodity trading advisors (CTAs), option selling managers, and discretionary traders in our monthly Managed Futures Spotlights; but one strategy type which doesn’t get as much attention is spread trading.
But one such spread trader is deserving of mention, having more than held his own thus far in 2009 while many other managed futures programs have seen a pullback after a great 2008, and having a strategy based in part on the continuing popularity of investing in commodity ETFs such as the USO, UNG, GLD, and GSG.
Today’s Managed Futures Spotlight highlights the EMIL VAN ESSEN LLC Spread Trading Program. Spread Trading is the simultaneous purchase and sale of something very similar, economically speaking. In commodity markets, that usually means buying one commodity while selling a similar one (buying Soybeans, selling Soymeal, for example) or buying /selling the same commodity but in different contract months (buying September 2009 Corn futures and selling December 2009 Corn futures, for example).
Depending on whether you buy or sell the spread - the goal of a spread trade is for the difference between the two sides of the trade to either get further apart or closer together. In our example above, you would want either July Corn rising faster than December Corn does, or December Corn falling faster than July Corn.
[Important Note: Outside of the US - Spread Trading can mean something completely different, with it being another name for spread betting. Spread betting is essentially how mainly UK citizens can go short stock, indices, etc., as tax and other laws make it prohibitive to short stocks as we do here in the US. Spread betting should not be confused with spread trading as we are discussing it here]
Who Is The Manager:
Emil van Essen is the President of EMIL VAN ESSEN LLC a registered CTA. Mr. van Essen has more than 20 years of experience in the futures industry in both Canada and the U.S. Additionally, he has been a registered Commodity Trading Advisor since 1997. His positions in the futures industry have included being an Institutional Futures Specialist for Prudential Securities, Director of Quantitative Futures Analysis at REFCO Global Ltd. LLC, Chicago, and Director of Managed Futures for the Bank of Montreal in Toronto, Canada.
At Bank of Montreal, Mr. van Essen was the Bank’s first director of Managed Futures and began testing and developing a Commodity Trading Advisor (CTA) selection model. He also established the bank’s first systematic, model driven, proprietary trading group.
Before becoming a commodities trader, Mr. van Essen studied honors mathematics at the University of Waterloo in Waterloo, Ontario from 1983 to 1986. He then left the University of Waterloo to accept a highly regarded position at Prudential Bache Securities where he became one of the youngest brokers to qualify for Vice-Presidency and to be accepted into Prudential’s elite International Presidents Club.
Emil has been a member of Mensa, has won awards for achievement in mathematics, and has authored two books on systematic futures trading.
Mr. Van Essen and his family reside in Chicago. He is married with two children; a boy aged 14 who is entering St. Ignatius College Prep in August 2009 and a daughter aged 7. In his free time Emil enjoys going to the gym, playing chess and poker, while also trying to find the next edge in alternative investments.
How Do the Programs Work:
The Emil Van Essen Spread Trading Programs deal in what industry veterans call calendar spreads. Calendar spreads are the simultaneous purchase and sale of two different contracts months of the same commodity market. For example, going long the December 2009 Crude Oil futures contract while at the same time going short the August 2009 Crude Oil contract.
Calendar spreads are a trade type somewhat unique to the futures and options markets, and come into being based on commodities markets like Corn having many different contracts based on when in the future they expire. There is not a single Corn futures market, for example. There are separate futures markets for Corn to be delivered in March, delivered in May, delivered in July, delivered in September, and delivered in December each year). There is no such mechanism in the stock market. For example, you can't buy the July IBM stock and sell the December IBM stock - there is only the stock and whatever price it is trading at.
The goal of trading a calendar spread is for the price of the near month contract to outpace the further out contact if buying the contract with a closer delivery date, and vice versa if selling the contract with the closer delivery date.
If you are wondering how/why the price for one delivery date would differ significantly from another delivery date, consider that during Hurricane Katrina, when the bulk of US oil refining capacity was shut down, the near month Gasoline contract skyrocketed higher (no one was able to get gasoline refined by the delivery date, making the gas that was available highly coveted and therefore highly priced), while the prices of Gasoline to be delivered many months out did not see such price appreciation (because the refineries would be back on line refining and delivering gas by then).
The Van Essen programs utilize both technical and fundamental analysis to generate signals on when to enter and exit their spread trades, and is mostly systematic in its following of those signals. The manager was not willing to share which technical indicators and methods are used, but did give us insight into what fundamental factors they look at.
The main fundamental factor used by Van Essen revolves around tracking the capital flows coming into and out of the commodity markets from the now very large commodity ETFs (At the end of June, there were 22 commodity ETFs with more than $54 billion in total assets, according to research from State Street Global Advisors.)
In aggregate, these 22 ETFs can and will hold very large positions in the commodity markets, thanks to loopholes and exemptions which do not require them to adhere to the same position limits that individual investors, CTAs, and hedge funds must.
At its base level, the Van Essen program looks to take advantage of the fact that these funds/ETFs will have to roll their large positions before each contract delivery date by selling the nearer month contract which the ETF will have to sell in a few weeks time, and buying the further out contract which the ETF will have to buy at that time. This is called Rollover Arbitrage, and we found a nice explanation and brief history of it at the following website: http://www.cisoptions.com/2009/07/us-natural-gas-fund-etf-stops-issuing-new-shares/
At the more advanced level – the rollover arbitrage isn’t as easy as it may sound above (just line up with the ETFs), and how exactly Van Essen plays this Rollover Arbitrage is what they believe to be their edge – not the fact that rollover arbitrage is possible. Unfortunately for our readers, how exactly they handle it is a tightly held secret of theirs.
For Van Essen, they typically enter their spread trade (usually selling the nearer month and buying the further out month) several months prior to the nearer month’s expiration, and usually exit at least one month before expiration of the nearby contract. Exiting the trade before the last month of trading is done in an attempt to avoid the potentially dangerous moves that spreads often make just prior to expiration (as in the Hurricane Katrina example above). Some special situation trades may last a few weeks to as little as a few days.
As could be expected from a program which looks at the capital flows based on ETFs tracking various commodity indices - the markets considered by the Van Essen program are a who’s who of markets included in the two most followed commodity indices: S&P GSCI and Reuters/Jeffries CRB, and include: Copper, Silver, Crude Oil, Heating Oil, Natural Gas, Unleaded Gasoline, Corn, Wheat, Soybeans, Live Cattle, Lean Hogs, Cocoa, Cotton, Sugar and Coffee. (Frozen Concentrate Orange Juice and Aluminum look to be the only CRB constituents not included, likely due to those markets lacking sufficient liquidity)
In August 2008, the EMIL VAN ESSEN Spread Trading Program was split into a high and low minimum program while maintaining similar trading strategies for each program to help prevent tracking error differences between larger and smaller accounts. The minimum investment for a managed account in the low minimum program is $500,000 while the minimum for the high minimum program is $2,000,000.
Overall the programs are very similar and investors can expect both to enter many of the same trades. Both programs average approximately 4000 round turns per million per annum. The average margin-to-equity ratio is 10% for both programs with a max of approximately 20%. Depending on margin use, it is possible for the higher minimum program to enter more positions and/or markets than the lower minimum program. This is the main difference between the two strategies. Targeted ROR can vary in the range of 20% to 50% depending on trading opportunities, with a maximum monthly peak to valley drawdown of 10%.
Also in August 2008, the high minimum program was deleveraged by 50% and on September 2, 2008, the low minimum program was also deleveraged 50%. This was done in an effort to significantly reduce the volatility of the program.
We view the Van Essen program as a truly unique strategy type (we know of no one else trying to profit from the large increase in assets put into long only commodity funds/ETFs), making it a great candidate for further diversification of one’s managed futures portfolio.
The uniqueness of the strategy can be seen in both the high and low minimum programs registering correlation coefficients of -0.26 against the BarclayHedge CTA Index. And if we didn’t have that stat to guide us, we could easily see that Van Essen is doing something differently here in 2009, as they have enjoyed success while seemingly everyone else in the managed futures space has struggled after a strong year last year.
Despite the early success of the program it has not come without a couple of bumps in the road. On two occasions the manager has had to deleverage the program. The first deleverage was reduction in the maximum risk per trade from 20% to 10% in January of 2008. Later in August of 2008 the program was split from one large program into the two versions (Low Minimum and High Minimum), and was then de-levered again by another 50% to make more attractive to potential investors.
Deleveraging is common amongst new and emerging CTA’s as managers often find the observed volatility many times their tested/expected volatility (chalk it up to the non linear nature of markets). The fact that Van Essen delevered is not necessarily a red flag, but it is something to take notice of when looking at the track record because everything before August 2008 was at the higher leverage ratios. So the compound ROR and DDs are based in part on a trading level that isn't done anymore. As such, a return which would have been +40% two years ago will now only be +20% at the new leverage levels. Investors looking at the program should take note of that and adjust their expectations accordingly.
According to the manager “The deleveraging resulted from a dramatic increase in spread volatility in the second half of 2007. This adjustment did not change the core strategy of the program but rather the size of the positions held. This was done to help substantially reduce the drawdowns that resulted from the increased spread volatility. We also began entering positions over a series of price levels to help manage volatility.”
In regards to potential changes to the program; the manager noted that typically, sharp down trending outright markets are the most positive for both programs, while sharp up-trending markets contain the most risk for drawdowns. Knowing this, Van Essen is currently working on a new risk management program that will hedge out the risks caused by extreme bull markets in a commodity. According to the manager “it is expected that when implemented, this risk management program will both improve gross returns while also reducing risk.”
One other thing to keep an eye on with the Van Essen programs is the current regulatory landscape and possibility that the US lawmakers will try and limit long only commodity index funds in some way. We like that the Van Essen program is trying to take advantage of the size and inflexibility of long only commodity ETFs, but the very fact that market participants are trying to profit by buying up the futures contracts of base commodities before the large funds get there (theoretically inflating their price) is what has many people calling for an end to these ETFs. The following Bloomberg piece sheds some more light on that: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a6zh_tMRK0kA
In the end, we believe in viability of spread trading (NDX Capital’s two spread trading programs were amongst our Top 15 Managed Futures programs in last week’s newsletter) and like Van Essen’s properties as a diversifier for a managed futures portfolio. Whether new regulations come to pass which may hinder their ability to profit from the rollover arbitrage remains to be seen, but for now things are looking up for Van Essen. Future success for the program will lie in the manager’s ability to continue to manage risk without having to deleverage the program.
IMPORTANT RISK DISCLOSURE
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The bulls were in control again during the past week in most sectors as a firm bid in the stock indices arena filtered into other commodities. The release of stronger than expected existing home sales numbers was the main catalyst, as well as another round of friendly quarterly results. The second consecutive week of constructive economic data aided another advance in most inflation sensitive commodities, although underlying fundamentals did cause problems in some of the food and protein sectors. The balance of the futures arena was fairly subdued as both the currency and interest rate sectors had the appearance that the dog days of summer have subdued investor appetites for the time being with more focus on vacationing than trading. Tidbits of a possible bankruptcy situation for a large commercial lender did subside when bondholders agreed to ante up for the time being, although thoughts of rising unemployment remain and overall market worry. Economic reports this coming week are again on the light side, but earnings from the retail sector could become a catalyst for market activity. U.S. equity index futures again posted a strong weekly performance with Russell 2000 futures +5.55% leading the way followed by the Mid-Cap 400 futures +5.49%, NASDAQ futures +4.53%, S&P500 futures +4.37% and Dow futures +4.15%.
Energy futures again posted solid advances during the past week as the sector support was seen from stronger U.S. economic news along with ideas of that demand from Asia will remain firm with the impressive performance their equity markets have experienced recently. Worries of lower domestic demand continued dissipate even with more announcements of refinery shutdowns by major oil players due to poor profitability. For the week Heating Oil futures ended +7.91%, followed by RBOB Gasoline Futures+7.19%, Crude Oil futures +5.37% and Natural Gas futures +1.18%.
The metals complex again found support by the wealth of positive U.S. economic inputs from various reports along ideas that Asian economic growth could be better than early anticipated. The positive Asian developments lead to the industrial metals leading the advance in the sector with Palladium +4.75% leading the way followed by Copper +4.09%, Silver +3.52%, Gold +1.66% and Platinum +1.30%.
The softs arena also showed promise as Sugar +6.53%, Cocoa +5.25% and Coffee +4.42% found support on world production worries due to weather issues. Grain activity remained in the doldrums from perfect U.S. growing conditions and a slower pace in the export market. Activity in livestock was weak as both Live Cattle and Lean Hogs saw weakness on less than satisfying market internals. For the week Lean Hogs ended -8.69%, OJ -7.90%, Cotton -6.95%, Wheat -4.33%, Live Cattle -2.14% Corn -1.27% and Soybeans -0.91%.
Currency futures activity was fairly subdued with a lack of participation stemming from a lack of news and summertime trading slowdown. The headlines of stronger economic data in the U.S. and in Asia as inflationary concerns did lead to the U.S. Dollar Index -0.77%and Japanese Yen -0.69% declining against the balance of the complex. The inflationary perception led to market participants maintaining a friendly bias of the continentals with the advances led by the Eurocurrency +0.69% followed by Swiss Franc +0.53% and British Pound +0.49%. The rate sector was fairly quiet with 30-year Bonds -0.05% and the 10-year Notes ending near unchanged levels.
Option trading managers, who have been this year’s top performers, are posting mixed results heading into the last week of the month with diversified traders like FCI ahead and index only traders ACE falling behind. The current estimates are as follows: ACE Investment Strategists -2.15%, Cervino Diversified Options -0.01%, Cervino Diversified 2x -0.45%, Crescent Bay PSI -2.07%, Crescent Bay BVP -4.15%, FCI OSS +2.49%, FCI CPP +1.68%, and Raithel Investments +0.37%.
On the whole it has been the Specialty managers who have performed best thus far in July – in particular Rosetta, who has found some solid footing in the grain markets and is ahead an estimated +3.28%. Elsewhere in the Agriculture markets, NDX Capital is finding mixed results between Abednego and Shadrach with estimates of +0.57% and -0.48% respectively. Finally, Emil Van Essen (featured above) has an estimated return of +1.7% so far in July.
With the end of the month right around the corner it looks like most multi-market managers will finish the month in the red once again. Nearly all multi-market trading styles are struggling right now, be it Long term, short term, systematic, or discretionary. The fact that so many managers are struggling tells us this is a poor environment, not structural problems with each manager, and if we assume the current environment will eventually turn to something else as they always do, this seems like the perfect time to get invested in a multi-market CTA or add to an existing allocation.
Heading into the last week of trading in July the only multi-market CTA solidly up for the month is Robinson-Langley at approximately +4.12%. Robinson-Langley has parlayed successful trades in grains, stocks and energies into a great month thus far. Mesirow Financial Commodities is flirting with profitability as well with the Absolute Return program at +0.06% est. and the Low Volatility Program at +0.04% est.
Managers in the red that are on the cusp of profitability include Integrated Managed Futures Global Concentrated at approximately -0.23%, Dominion Capital Management Sapphire Program at an estimated -0.38% and DMH at -0.71% est.
Those further down the list include Clarke Global Magnum -1.17% est., Lowe Wolf Investments, LLC Diversified at -1.53% est., Clarke Global Basic -1.69% est., Hoffman Asset Management at -2.13% est., Attain Portfolio Advisors Strategic Diversification at -2.15% est., Futures Truth MS4 at -3.07% est., Futures Truth SAM 101 at -5.63% est., and APA Modified at -7.25% est.
Short term index traders are did not like the sharp rally in equities last week, with Paskewitz Asset Management Contrarian 3X Stock Index now down approximately -5.03% for the month while MSLO is at -0.63% est.
Trading systems ended last week with a moderate performance across day and swing time frames.
Beginning with the day trading systems, EVP2 US outperformed other day trading systems with two winning trades of total $1722.08, followed by CobraII ERL again with a two winning trades of total $1095.87. Compass had two trades tallying to $930.95 while DAX system Rayo Plus 1815 managed +$657.50 on three entries into the market. Other potential winners are in the order of Upper Hand ES with $645.00 on a single trade while PSI! ERL made $600 on two winning trades followed by DAX system ATB Welcome v2 with $380.
Finally, ViperII ES traded every day in the past week with mixed performance totaling -$315.25 while Schooner EC lost a small amount at -$35.81 and Rayo Plus DAX disappointed with two consecutivse losing trades totaling to -$1307.5.
Moving over to Swing systems, top performers of week were led by Strategic SP and ES with +$2890, followed by AG Mechwarrior ES with $65. Finally, Ultramini ES had three trades for net loss of -$802.50 for the week.
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.