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Managed Futures Spotlight: HB Capital
November 23, 2009
As we have mentioned more than once or twice in this space - 2008 was a good year to be invested in most types of managed futures trading programs thanks to record volatility across nearly all market sectors, while 2009 has been a struggle for those same programs as volatility has plummeted. On the opposite side of that spectrum are most option selling programs, which did very poorly in 2008 but have rebounded thus far in 2009 (the rebound has been more pronounced in option sellers who focus on more than just stock index futures options).
Many investors are asking what is working in this current environment, and the answer has been multi-market (non stock index) option selling programs. The problem with those programs for most investors, however, is the steep drawdowns they suffered in 2008 when volatility spiked. Well, not all multi-market option sellers took a dive in 2008, and this month’s Managed Futures Spotlight highlights an option selling manager that was able to keep his head above water and avoid the drawdown that plagued most option programs last year: HB Capital Management.
Who is the Manager:
HB Capital Management is owned and operated by Mr. Howard Bernstein, a 20 year veteran in the managed futures industry. Mr. Bernstein began his career in 1989 when he established the original version of HB Capital Management, Inc. a Commodity Trading Advisor that ran a long term trend-following program across a diversified set of markets. Mr. Bernstein managed accounts in this program until the late 90’s when, in his opinion, commodity market trends began to shorten and become more difficult to trade. Overall, he traded the trend following strategy for approximately 9 years and managed approximately $5 MM at the program’s peak.
After shutting down the trend following program Mr. Bernstein left the managed futures industry for 5 years before returning in 2004 at Financial Commodity Investments, Inc. (FCI), a successful multi-market option selling CTA in their own right. After a two year stay at FCI, Howard decided to become his own boss again and re-start HB Capital Management, Inc., this time as a discretionary commodity option selling program. HB began trading client accounts in March of 2008 and Mr. Bernstein is now managing approximately $24 million in this trading program.
Mr. Bernstein holds a Bachelor of Arts degree from Rutgers University and a Masters degree in Geology from the University of North Carolina, Chapel Hill. He has worked as a geophysicist for the U. S. Geological Survey and as a geologist for the Federal Energy Regulatory Commission.
Other key employees at HB Capital Management include Mr. Neil Stoloff who is an Associated Person of HB Capital Management as well as the firm’s Compliance Officer. Mr. Stoloff also manages the firm’s offsite emergency backup location in Michigan and has authority to execute trades if necessary.
How The Program Works:
The HB Capital Management trading program primarily employs a “premium collection” strategy where the manager will sell (or “write”) options (both puts and calls) on futures contracts. This type of trading strategy looks to sell out of the money options and collect the risk premium up front. For those that are not familiar with this type of trading please refer to our Option Selling Strategy Focus newsletter for more information at http://www.attaincapital.com/managed_futures_newsletter/239 .
The big difference between HB Capital and nearly all other option sellers is that HB Capital operates on a wide spread of traditional commodity markets – not just stock index futures options like the bulk of option selling managed futures programs. HB will deploy their model on markets such as coffee, grains, precious metals, currencies, and energies, which by definition diversifies their risk away from volatility spikes in any single market or due to any single event.
But no matter what markets or how many you operate on, option sellers remain a risky proposition. The old comparison those who have been burnt by option sellers use is that option selling is like picking up pennies in front of a freight train. One misstep and that freight train is going to get you. According to Mr. Bernstein, managing this ‘blow up’ risk is the key component to the option writing strategy employed by HB Capital and his team.
Their trading philosophy is not like the common option selling technique of selling options in each new cycle, and instead tries to be patient and wait for lower risk trading opportunities to present themselves. HB prides themselves in their ability to remain patient and not force trades that do not fit into their predetermined risk parameters, as evidenced by Mr. Bernstein’s views that he would rather sit on the sidelines for months at a time rather than take trades just for the sake of seeing activity in the account. This is in stark contrast to most option selling programs who sell the next month’s options as soon as this month’s expire worthless, creating an environment where the account is always at risk of a volatility spike (proponents of that style would argue that they are always benefitting from time decay).
On average, the typical risk per trade HB targets is 2%, which means that on the $90,000 minimum account size the manager will be looking to risk around $1800 per trade. The max risk per trade that Mr. Bernstein has allowed in the past is 5%, which is the equivalent of $4500.
HB also attempts to control risk through close monitoring of margin usage. With margin usage what the exchange views as the amount an account could lose in the course of a day, and some option selling managers using margin of up to 50% to 70% of the account’s value day in and day out, the fact HB only uses 10% on average speaks to their risk controls.
The average margin-to-equity ratio is 10% (quite low for an option seller), with a historical max of 25%. Another risk control is a temporary program stop trade if a -15% drawdown were to occur, in order to reevaluate the strategy and/or market conditions. The result of these risk controls has been a maximum intra-month drawdown of -6% in May-June of 2009; when a rally in wheat caused a drawdown of 3 weeks. Given the short track record length, we can probably expect 1.5 times that number at some point in the future.
But HB’s focus on risk aversion (in the riskiest game in town) has benefited HB clients thus far during times when other option selling managers have struggled. October 2008 is a great example of a time when it paid to be risk adverse as an option seller. Many option programs, including those that trade commodities and those that trade S&P options, got hammered in October of 2008 when volatility sky rocketed across all market sectors. In contrast HB Capital finished October 2008 up 1.07%. [Past performance is not necessarily indicative of future results]
In addition to closely monitoring risk on a per trade basis, the HB program is designed to weather all types of macro market environments by trading options in a variety of non correlated commodity markets including coffee, grains, precious metals, currencies, and energies. This portfolio of markets was chosen not just for the diversification it provides, but also because the manager believes these markets offer higher premiums than can be had in stock indices with better odds of expiring worthless. HB also takes into consideration the length of time to contract expiration and will only consider medium-dated out-of-the-money options (those expiring in one-to three months), believing this approach increases the odds of rapid time decay in the value of options sold once the market moves in the trade’s direction.
Finally, it is worth noting that the trades put on by HB are discretionary trades, with Mr. Bernstein choosing when to enter a particular market with a new trade. He does not follow a systematic model to generate signals, although he does use both technical and fundamental analysis when determining entry and exit points (if necessary). Typical technical analysis methods used include the study of price charts, market volume and momentum to forecast the future course for prices. Implied and historical volatility of the option and its underlying commodity are also studied. On the fundamental side he will look at characteristics like supply and demand, seasonal movements, weather, business and economic factors, as well as governmental policies and other worldwide events which can influence commodity markets.
After a very rough year in 2008, option selling programs are back in vogue this year as the top performing managed futures sector. Consolidated market activity and a huge decrease in global volatility have allowed option sellers of all shapes and sizes to jump back in with a vengeance. Many investors are leery of jumping back into the option selling pool after being burned in 2008. But the fact that Mr. Bernstein was able to navigate his program through 2008 and its black swan/10 sigma event volatility spike, has many considering the program. It was much more common to see the opposite scenario last year, where many an option manager did not manage risk well and subsequently had to close their programs. The fact that HB not only survived, but posted a profit in 2008 is a definite feather in his cap.
Mr. Bernstein’s background as a trader is impressive as well. It is always nice to know that a manager has “been there before” and has experience handling the trials and tribulations of the job. Many newer managers can fall into the trap of risking too much to produce returns, thinking that high returns are the secret to raising a lot of money. But most investor s would rather see low risk than high returns, and this is where Howard’s experience and steady demeanor help him the most, in our opinion, as he does not seem likely after our review of putting his program and livelihood at risk to produce profits when the trading opportunity simply is not there.
Another thing we like with the HB program is its discretionary nature, yet systematic risk targets. With the discretion on when to put a trade on, the manger can wait for a volatility spike in a market before putting a trade on to maximize the premium received and avoid a trade the risk far outweighs the reward. While at the same time, there isn’t the same type of discretion on when to get out if things go wrong, with the 2% to 5% risk per trade targets in place.
Playing devil’s advocate - there is a famous saying that “managers are only as good as their last trade” and that definitely applies to option sellers as the opportunity for disaster is always around the corner. The fact of the matter is that no matter how much analysis a manager does or how many risk controls are in place, it is virtually impossible to see every potential pothole in the road ahead. Writing options in markets like Crude Oil, Natural Gas, even Gold is always going be dangerous due to potential geopolitical events and potential for black swan type moves. Even the best managers will not be able to predict when missiles are launched or even when currencies are de-pegged from the dollar. Each investor should keep this in mind before signing up for an option selling program with short options theoretical unlimited risk.
Outside of the doomsday scenario there are a couple smaller red flags to consider. First, the track record for this program is still short at just under two years (20 months). In a perfect world we would like to see closer to thirty-six months of trading before recommending a program. Second, there are some liquidity constraints to be considered when executing this type of program. We have seen that in the past that it becomes much harder for managers to maneuver in the options markets as there AUM continues to grow. It is one thing to exit 100 short Crude Oil options when they go 2% against you, and quite another to have to get out of 5,000 short options. This why most option sellers have to quickly cap their programs at $50mm to $100mm, and why most CTAs avoid trading in traditional commodity markets (there is a definite ceiling and they want to be larger managers than those markets will allow), HB is managing approximately $25mm in customer assets, currently, meaning he could be closed to new investors sooner rather than later.
Overall, the trading that we have seen out of HB so far has been impressive. Mr. Bernstein has already navigated one of the largest mine fields in financial history (2008) which literally wiped out a good 50% of option selling traders, and we expect he will continue to produce consistent returns in the future. The key to success will be managing his growth effectively while also remaining conservative with his trading. The danger is that as AUM continues to grow it will be necessary for HB to put on trades closer to the market in order to generate the type of return his customers expect.
- John Cummings
IMPORTANT RISK DISCLOSURE
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Feature | Week In Review: Mixed bag as energy and equities cool off, but gold continues rally | Chart of the Week
Market activity was a bit fractured as some sectors continued to build on the recent firm tone while others of where a bit under the weather on weaker economic data and ideas that the high unemployment rate will hurt the velocity of a recovery. The continued stance by most central banks leaving key lending rates unchanged with hints that low rates would be the norm in the foreseeable future also led to mixed sector activity. European news was mixed as export and growth figures improved, but worries that investor confidence recently fell kept a cap on advances for the week. Asian headlines continued as a market supporting factor with news of improving economic conditions not only in Hong Kong, but Japan as well. The lineup of economic reports this week is fairly light with the Thanksgiving holiday bunching some housing and market sentiment figures together headlined by the existing and new home sales. Metal futures were fairly active during the past week posting another week of advances as strong economic news from emerging economies continued to give this sector a strong backing led by Silver +7.08% followed by Platinum +3.74%, Gold +2.70%, Palladium +1.57% and Copper +1.03%.
Commodity and Food products were mostly higher as weather issues and ideas of stronger demand from emerging economies continued to spark investor support in most of the complex. Weather concerns again led to higher prices in the grains as the late U.S. harvest and late SRW belt wheat seeding continued to spark ideas that it would lead to lower output. Soybeans +5.98% led the way followed by Wheat +3.82% and Corn +0.15%. The livestock arena posted a rally as strong pork demand helped Lean Hogs +5.98% lead the way with Live Cattle +0.76% following along on ideas that a pickup in exports could soon aid price for beef as well. The Soft arena was mixed as weather worries in the Southern Hemisphere helped spark support in Cocoa +5.26%, Cotton +3.80% and Coffee +1.15%. OJ -3.10% and Sugar -1.10% were under pressure from ideas that supply stocks are not as dire as earlier anticipated.
The energy sector was mostly higher during the past week as supply and demand scenarios improved a bit on the latest reports in the U.S. sparking RBOB Gasoline +3.05% to lead the rally followed by Crude Oil +0.86% and Heating Oil +0.73%. Natural Gas futures -0.64% were hampered by mild U.S. weather and heavy supplies.
The Stock Index futures complex ended the week mostly lower as pressure stemmed from some weaker economic results along with weaker quarterly results from a major computer firm. Activity was also hampered by profit taking ahead of not only the Thanksgiving holiday, but end of the year book squaring especially with the strong improvement in market internals during the last 6 to 8 months. For the week the tech heavy NASDAQ futures -1.38% led the way down followed by Mid-Cap 400 futures -1.52%, Russell 200 futures -0.52% and S&P 500 futures -0.12%. Dow futures 0.60% were a bit higher on sector investing.
The U.S. Dollar Index +0.49% gained some ground against the majors with book squaring versus the higher yielding currencies being a main feature. Strong metal prices and slow growth in the U.S. versus that of emerging economies was a main catalyst for the rally in Japanese Yen +0.96%. The British Pound -1.06% led the majors lower followed by the Swiss Franc -0.52% and Euro -0.30%. The rate sector remained firm ahead of the holiday week with 30-year Bond futures ending +0.96% followed by 10-year Note futures +0.74%.
Heading into the end of the month, Option Trading managers continue to be the top performers in November. Leading the way all along has been Raithel Investments with an estimated gain of +5.60%. Other estimates for the month include Ace Investment Strategist +2.85%, Cervino Diversified +1.47%, Cervino Diversified 2x +2.97%, Crescent Bay PSI +2.56%, Crescent Bay BVP +5.01%, FCI OSS +3.19%, FCI CPP +2.24%, HB Capital +0.20%, and Oak Investment Group +4.57%.
Multi-Market managers turned up the heat last week and are on the verge of their best month of year as nearly every manager we track is posting profits for the month. Perhaps, the fact that so many managers have been successful in November is a sign that we are finally starting to see a return to normalcy in this sector. Thus far the top performer for the month is Integrated Managed Futures Global Concentrated at +3.30% est. Integrated continues to have success with long commodity and foreign currency trades. Not far behind Integrated is Hoffman Asset Management at +2.85%. Hoffman has spent nearly the entire month near the top of the leader board and continues to post impressive numbers in November.
Other profitable managers include Clarke Global Basic +2.42% est., Robinson-Langley Capital +1.88% est., Clarke Global Magnum +1.27% est., Mesirow Financial Commodities Absolute Return +0.72% est., GT Capital +0.51% est., 2100 Xenon Managed Futures Program (2X) +0.49%, Futures Truth SAM 101 +0.48% est., APA Strategic Diversification +0.30% est., and APA Modified +0.02% est.
There are still a group of managers that are in the red. Programs in this group include Mesirow Financial Commodities Low Volatility -0.06% est., Sequential Capital Management -1.04% est., Dighton Capital USA Aggressive Futures Trading -1.41% est., Futures Truth MS4 -1.86% est., Dominion Capital Management Sapphire -2.30% est., Quantum Leap Capital -3.29% est.
Short term index trader Paskewitz Asset Management Contrarian 3X St. Index is up +0.67% est. in November.
Specialty manager performance has been mostly neutral with some slightly positive weeks and others slightly negative. Leading the way has been Emil Van Essen Spread Trading Program which is ahead +0.73% brining their YTD estimate close to the enviable +20% number (+18.39% through October). Agriculture traders NDX and Rosetta had a slow month with NDX Abednego +0.12%, NDX Shadrach +0.02%, and Rosetta -0.19%.
Trading systems had mixed performance last week amid quiet market conditions. The slower place kept a large portion of the programs on the sidelines for the week and those that did trade were less active than usual. Unfortunately, it’s unlikely that trading will pick up with the abbreviated holiday week in observance of Thanksgiving on Thursday. Look for momentum to pick back up when traders return from vacation a week from today.
Beginning with the swing trading programs, Strategic SP and ES had similar results for their respective contracts, +$2,425 and +$440 on two trades each. Both programs entered the week with a long bias and reversed their positions early in the week. Polaris ES also exited a long position from the week prior for +$695 on the single trade. Both AG Mechwarrior ES and Bounce ERL had small winning trades on Monday/Tuesday good for +207.50 and +$60. Shifting to interest rates, both Jaws US Daily and Jaws US 60 were unsuccessful last week down -$280 and -$580 respectively.
Changing time frames, BounceMOC ERL was the only day trading system that finished the week ahead up +$540 on a single trade from Monday. Other results included ATB Trendy Balance v2 Dax -€70, BetaCon 4/1 ESX -€110, Upper Hand ES -$197.50, Waugh ERL -$360, Rayo Plus Dax -€852.50 and Clipper -$1,100.
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.