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Option Selling Managed Futures programs - Where do they go from here?

July 6, 2009

 

First came love, then came marriage….then came a nasty divorce where most option selling managers “blew up”, losing loads of investor money with incorrect bets against spikes in volatility.  And so goes the story of Option Selling managed futures programs from 2002 through the end of last year.

But not all Option Sellers “blew up” and not all investors looked for a divorce.  There are several still Option Selling CTAs alive and kicking, and there are actually some brave investors who have been re-engaging this unique sector of Managed Futures. And wouldn’t you know it,  that just happens to be the one Managed Futures sector actually doing well this year.

So what is next for Option Sellers?  Is getting involved now like getting on a broken elevator which will soon plunge lower? Or is the worst of the financial crisis behind us, leaving Option Sellers in a sort of ‘Golden Era’ of low volatility like they had from 2002-2006.

What is the next chapter for Option Selling CTAs?

First, some history:

As we’ve touched on many times in this newsletter, option selling strategies performed very well in the historically low volatility of 2002 through 2006. The typical performance for these programs (which generally speaking sold out of the money options or option spreads on S&P 500 futures) was month after month of gains without any losses.

Take the popular Zenith Resources program as an example. The Zenith Resources Index program put together an amazing stretch of 40 consecutive positive months between February 2003 and January 2007. This type of consistency is just the thing most investors crave, and investors flooded into Zenith and other option selling managers throughout 2005 and 2006 (and even into 2007 as cracks in the option selling armor started to show).

The assets under management in Option Selling CTAs tracked at Attain swelled 53% from $491 million at the end of 2005 to $752 million as of December 2006 as investors couldn’t resist the lure of consistent returns Option Selling managers provided.  But just as assets in Option Selling CTAs were peaking, the very thing which had fueled their success (low volatility) started to unravel.

First there was the February 26th, 2007 market selloff (the Dow down over 400 pts), and the major indices in the US finished the week down more than 4% on average) fueled by a 10% correction in the Chinese stock market – this quickly took the VIX from a low of 9.7 to a high of 19.01. While this 10 point move doesn’t seem all that significant today, at the time it represented a doubling of the volatility in really a single day.  Option sellers lost money nearly across the board.

Next came July 2007, when the credit crisis really started to have actual implications, like two Bear Stearns hedge funds going under, and global stock indices lost about -5% in the final week of July.  This event saw the VIX double again, from a low of 12.43 in June 2007 to a high of 24.17 in July 2007, and with that doubling came more option seller losses, as well as the first closings of Option Selling programs.

From there, it was rumors about a rogue trader losing several billion for a European bank over the Martin Luther King holiday when the US markets were closed which sent the VIX up to  a new multi-year high of 37.57 (which was about 300% higher than it had been just a year earlier).  This took a few more option sellers down, with one popular program losing about -70% in January 2008 alone.

It appeared we may not spike higher, and just stay at that level as the VIX averaged about 27 over the next seven months – but the market had other ideas come September 2008, as the collapse of Lehman Brothers sent the VIX up another 30% to a high of 48.  Option sellers were now seeing big losses, in the range of -20% to -40%, but many thought the worst must be behind them, and if they could just weather the storm and roll their options further out – they may survive the crisis.

But once again, the market had other ideas, and as the stock market losses worsened behind failed bailout bills, mounting bank losses, and lack of support for government plans to solve any of it, the VIX exploded upwards again to an all time high of 89.53 in October and 81.48 in November. This was the final straw for many Option Selling CTAs, as no amount of rolling positions to further out strikes could save them from margin calls and forced liquidations.

When the dust had settled, assets under management by Option Selling CTAs Attain tracks had fallen by over $500 million, or -66%, from $766 million to just $296 million, with 8 out of 18 managers having closed or in the process of closing.

Various Option Selling CTAs Assets Under Management (Dec '05 - May '09)

Name

Dec-05

Dec-06

Dec-07

Dec-08

May-09

ACE Investment Strategists

$137,100,000

$166,000,000

$150,700,000

$51,200,000

$64,200,000

Ansbacher Investment Mgmt

$161,000,000

$171,000,000

$127,000,000

$13,000,000

$10,000,000

Argus Capital Management

$373,000

$9,366,000

$378,000

closed

closed

Ascendant Asset Advisors

$2,745,000

$14,265,000

$62,268,000

$1,252,000

$589,000

BC Capital Management

$18,022,000

$28,827,000

closed

closed

closed

Cervino Capital Management

$122,000

$1,963,000

$2,027,000

$6,180,000

$7,135,000

Crescent Bay Capital Management

$58,000

$1,800,000

$2,200,000

$4,730,000

$3,780,000

Diamond Capital Management

$23,189,000

$26,822,000

$33,834,000

$8,766,000

$7,026,000

Farr Investments

$30,691,814

$53,632,644

closed

closed

closed

Financial Commodity Investments

$343,000

$5,550,000

$29,661,000

$14,545,000

$15,982,000

K4 Capital Management

$2,980,000

$16,924,000

$24,773,000

$23,528,000

$23,650,000

LJM Partners

$61,242,000

$125,302,000

$198,523,000

$80,966,000

$81,580,000

Outrigger Funds

$10,023,000

$16,225,000

closed

closed

closed

Parrot Trading Partners

$4,100,000

$7,200,000

$15,500,000

$8,000,000

$4,000,000

Raithel Investments

$520,000

$5,158,000

$5,285,000

$4,758,000

$3,719,000

World Capital

$13,777,000

$27,057,000

closed

closed

closed

Zephyr Asset Management

$3,757,000

$13,173,000

$9,293,000

$251,000

closed

Zenith Resources

$21,844,000

$62,726,000

$105,165,000

$79,562,000

$30,081,000

 

 

 

 

 

 

Total Option Trading AUM

 $491,886,814

 $752,990,644

 $766,607,000

 $   296,738,000

 $251,742,000

 

 

 

 

 $ Change

from peak

 $(514,865,000)

#This table includes Option Selling CTAs known to Attain during the periods listed,

% Change

from peak

-67.16%

 and may not include all option selling CTAs active during these time periods.

 

 

 

                  Source: BarclayHedge (www.Barclayhedge.com)

Now what?

It is something of a ‘Catch 22’ for novice managed futures investors, that the riskiest managed futures sector by many accounts (option selling) just happens to be the most affordable one (minimums are usually $100K and lower versus $3 Million an up for the best systematic CTAs).

Top that off with the performance of Option Selling CTAs up until the 2007/2008 period, when they appeared to be the programs with the highest returns per unit of risk (thanks to basically no risk showing in their track records), and many first timers to managed futures started out with Option Selling CTAs.

This proved to be unfortunate, as many of the investors new to managed futures who jumped on option selling CTAs lost money with them when volatility spiked to all time highs. But it isn’t just the money they lost which is unfortunate; it is also that many of them got a sour taste in their mouth about managed futures and abandon the asset class altogether.  In short, they had the right asset class to diversify their stock market investments, but the wrong sector last year.

To now abandon that asset class would be a mistake in our opinion, because while option selling CTAs are technically in the managed futures universe – they do not resemble the managed futures index performance nor the performance of “normal” CTAs in the least. They are betting against volatility in the stock market for the most part, while most others in the managed futures asset class are betting on volatility in commodity, currency, and financial markets. Option sellers, by their very composition, are likely to do poorly when Managed Futures as an asset class do well (see 2007 and 2008 as prime examples). In that regard, they are very much like an investment betting on the stock market not going down (which is not exactly the same thing as an investment betting on the stock market going up, but it is close).

But with those option selling strategies which survived the 2007/2008 volatility spike some of the only Managed Futures investments doing well thus far in 2009, the question of whether they do belong in a portfolio of Managed Futures investments needs to be asked.

Option Selling has a place in some portfolios, but is NOT for everyone

After living through the past two years and seeing firsthand the damage volatility spiking over 800% in around 20 months can do to an account – we can unequivocally say that Option Selling CTAs are not for everyone.  For the average managed futures investor (read $50K to $150K) the profits generated from selling options and/or being involved in a managed option selling program is just not worth the risk of the worst case scenario, which is losing 60% to 120% of your account. 

And as hit on above, for the smaller investor who only has $50K to $150K to put into a managed futures investment – investing into an Option Selling managed futures program does not really give you managed futures exposure. You are technically invested in managed futures, but your returns aren’t likely to mirror the performance of the managed futures indices and their desirable stress period performance.

Now, having said that; we do believe (even after seeing roughly half of the Option Selling managers blow up over the past two years) that there is a place for Option Selling in a managed futures portfolio. We touched on this in October of 2008, when volatility was at all time highs, saying that it was likely a great time to play the contrarian for well heeled investors and sell into that volatility by investing with a volatility selling Option Seller.

But beyond the contrarian play (which has mostly gone away as volatility has retreated back down to around 30 over the past 6 months), there is also the argument that the survivors of the volatility spike are better suited to performing through future volatility spikes.  Another factor to consider, the hidden risk of option selling is not really hidden any longer.  The risk is right there to be seen in the track records of managers like ACE, Cervino, and FCI.  If volatility goes back down, and spikes back up, we’re likely to see the same types of losses for these managers.

There is also something to be said for an actively managed option strategy, and/or ones that utilize complex trading techniques (like Cervino) versus “set it and forget it mangers” like the now defunct World Capital. The former can and will vary between being short volatility and long volatility, thus isn’t guaranteed to see losses when volatility spikes, while the latter only profits when volatility does not spike and their options expire worthless. The active manager will not see the consistent returns of the passive manager just betting against a volatility spike, but as we’ve seen – those consistent returns don’t always make up for the large single month losses experienced when volatility spikes.

Additionally, diversified option mangers such as FCI who trade across multiple markets have an extra level of protection that managers only selling stock index options do not have. They are not as concerned about volatility spikes in the stock market, and must have the equivalent of those volatility spikes across several markets simultaneously (or a massive increase in correlation) to get into trouble.

Finally, having some Option Selling managed futures programs in your portfolio can be a nice bonus when we’re in choppy sideways conditions like we’ve seen for much of the past few months. It only follows that if big, unexpected moves are poor environments for option sellers; small, range bound moves are good environments for them. When the systematic multi-market CTAs your invested in are struggling, Option Sellers can be just what the doctor ordered. There are sure to be some more events as the financial crisis unwinds which could spike volatility back up to the 50s or 60s, but it is more than possible that a lot of that has already been priced into the VIX. If those events fail to materialize because of continued government intervention, for example, Option Sellers will be selling an inflated asset.

Still, even the most sophisticated option traders have exposure to a risk that normal, non option trading CTAs don’t have.  That risk comes from the fact that the price of the option isn’t tied exclusively to the price of the underlying asset. The price of the option is also tied to the implied volatility of the underlying asset. This is just a fancy way of saying that the extra risk with option trading is that you can lose more than you are “supposed to”, because the price of the option can go up many times what the underlying asset moved.  With a so called normal CTA, they only have the risk represented by the price move of the commodity itself.

So, given the past performance of the Option Sellers, the fact many have blown up, and the extra risk they carry, we recommend investors only target around 0% to 20% of their managed futures allocation to option selling (0% being conservative, and 20% on the aggressive end). 

-Jeff Eizenberg 

 

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: Month in Review: Most CTAs post June losses as choppy conditions persist

Overview

U.S. stock index futures staged a broad-based rally during the first half of June only to moderate in the last week of trading. The end result was the majority of the U.S. stock index futures advancing on the month, ranging from +2.93 % for the Emini Nasdaq (NQ) to -.47 % for the Mini Dow futures (YM) with the TF, EMD and ES all falling in between. Bond prices were surprisingly correlated to the stock market after initially declining early in the month while stocks were advancing, with the 30 Yr Bond + .60% while the smaller duration bonds like the 10 Yr Note were -.50% or more. Foreign bonds saw sharper advances than their U.S. counterparts, particularly in the Eurex Bund (10 Yr) and Eurex Bobl (5 Yr) which were +1.8 % and + .8 % respectively for the month.

Moving on to commodities, there was a lot of disparity within each market sector. In the grain sector, Corn and Wheat were down a staggering -20.11 % and -18.87 % while Soybeans managed to finish the month + 2.59 %. Moving on to the energy sector, Crude Oil, Heating Oil and RBOB Gasoline were +4.55 %, +3.77 % and + .63 % while Natural Gas was – 3.72 %. Moving on to the metals sector, Silver saw the largest declines – 13.03 %, while Gold and Platinum were down a more modest – 5.40 % and -1.81 % yet High Grade Copper finished +2.76 %.

Livestock markets were mixed as well with Lean Hogs falling – 8.07 % throughout the month while Live Cattle advanced + 4.19 %. Finally, soft commodities were mostly down with Coffee – 14.08 %, Cotton – 7.42 %, Cocoa – 3.57 % but Sugar finished + 6.57 % for the month.

Managed Futures

As mentioned above in this week’s topic, 2009 has been an excellent market environment for most option trading managers.  June was no exception, as option traders on the whole were the month’s top performing investment strategy.  Leading the way was FCI CPP program which returned an estimated +8.02% in June bringing the program’s 2009 total up to +23.12% (new highs).  FCI’s original OSS program was not far behind with an estimated +5.50% return in June bringing its 2009 total up to +17.30 (remains down -23.32% from all time high).  Elsewhere, the balance of Option traders we track also posted positive results in June with the following specifics (estimated): ACE Investment Strategists +3.86%, Cervino Diversified Options +1.42%, Cervino Diversified 2x +2.89%, Crescent Bay PSI +1.5%, Crescent Bay BVP +1.25% and Raithel Investments +1.69%.

Specialty Managers (those that focus on a target market or apply a unique strategy) had mixed performance as market fundamentals continued to plague the agriculture markets but benefited spread traders.  Emil Van Essen was the month’s top performer earning an estimated +1.97%.  Mr. Van Essen’s strategy is designed to capitalize on the price discrepancy trends between front month and back month futures contracts (i.e. August and December 2009 Crude Oil). Many of these trends move actively as a result of fundamental shifts by producers and suppliers of commodity based products and in turn are exploitable.  Elsewhere, NDX Abednego earned +0.17%, NDX Shadrach was also ahead + 0.74% and Rosetta fell back -5.23%. 

Multi-market style traders wrapped up the disappointing second quarter of 2009 with a likewise disappointing month of June.   Most managers finished Q2 in the red and are now hoping for a big comeback in the second half of this year.   One manager who zigged while the others zagged was Integrated Managed Futures whose Global Concentrated program was up approximately +1.14% in June.   The program, which trades 60+ markets around the world, had success trading in various sectors including the softs, energies, meats, and foreign treasuries last month.   Congrats to Mr. Austrup and his team on a great month!

Elsewhere the picture wasn’t as pretty.   Some managers were able to finish near breakeven after a late month rally or just by cutting back on trading altogether.    Dighton USA Aggressive Program was one manager who decided to stay away from the markets and after a fairly quiet month finished near breakeven.    Futures Truth Co. SAM 101 was on the more active side and rallied over the last few trading days in June to finish at approximately -0.04% while the FTC MS4 Program was down -1.70%.   Mesirow Financial Commodities Absolute Return -0.32%S est. and Mesirow Financial Commodities Low Volatility at -0.09% est. both hung around breakeven for the month as well.  Clarke Capital Management had posted a small loss as well with the Global Basic Program at -0.59% est. and Global Magnum at -0.35% est.   APA Strategic Diversification also was down at -1.25% est. while the APA Modified Program was hit harder at -5.33%. Other managers in the red include DMH Asset Management -1.72% est., Robinson-Langley -2.53% est., Lone Wolf -4.53% est. and Hoffman Asset Management -6.00% est.

Shorter-term index trader Paskewitz Asset Management Contrarian 3X Stock Index was up slightly at approximately +0.16% as was MSLO at an estimated +0.15%.  Meanwhile, Pere Trading Group couldn’t seem to get on the right side of a trade all month and was down an estimated -8.55% in June.

 

Trading Systems 

Swing trading systems outperformed day trading systems in the month of June. The majority of the swing programs were able to capitalize on overnight moves that were often in excess of 1 % from overnight trading. Day trading systems trading on U.S. markets were out of sync throughout the month but those trading the German Dax hit their stride particularly towards the end of the month.

Beginning with the swing programs, Jaws US 60 was the cream of the crop + $1,738 on three trades for the month. Close behind was Ultramini ES +$1,560 on three trades as well. Moving on to more active systems, AG Mechwarrior ES was able to grind out +$680.30, while sister systems Strategic SP and Strategic ES were - $2,487.50 and - $1,485 respectively. Jaws US 400 was the remaining swing system that was able to finish above water +$290.80 on one trade early in the month, while Waugh Swing ES lost -$492.50 on its debut trade.

Moving on to the day trading systems, the aforementioned Dax programs were able to navigate the choppy waters in June. From top to bottom those results were ATB Welcome v2 Dax +4,085€, ATB TrendyBalance v1 Dax +2,545€, ATB TrendyBalance v2 Dax +1,297.50€, Rayo Plus Dax +1,420€ and Rayo Plus 1815 Dax +707.50€.

Of the U.S. based day trading systems, Cobra ERL and Upper Hand ES were the only programs able to post positive results +$521.26 and + $217.50 respectively. Other system results were BetaCon 4/1 ESX -460€, Viper II ES - $793, Compass SP -$1,448.55, Waugh ERL -$2,216.55 and Clipper - $2,370.

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.