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Looking for a way to play long volatility - Trading Systems are worth a look

October 20, 2008


Trading systems were all the rage in 2000, 2001, 2002 as the stock market was selling off heavily after the internet stock bubble burst.

But many systems which were developed during that time fell on hard times between 2003 and 2006 when the volatility in stock index futures slowed to a crawl thanks to a steadily climbing stock market. This caused many people to seek out managed futures programs which weren’t as tied to volatility, and the popularity of trading systems has been on the wane every since.

But fast forward a few years to the present and the record high volatility seen recently, and it isn’t too much of a stretch to believe that we may now be in the sweet spot for system trading again. The era of the trading system may be coming back after lying low for several years.  

Many clients have been looking for investments which perform well in this high volatility environment, and have been discouraged to see the high minimum investment amounts of many of the “long volatility” managed futures programs (APA Modified = $250K, Dighton = $100K, etc)

But few appear to have been looking at what may be an obvious choice for long volatility exposure at much lower minimum investment amounts in the $5,000 to $30,000 range. That choice has been right under their noses on the Attain website, and is none other than automated trading systems.

Below are four stock index trading systems which we feel can capitalize on the current high volatility market environment.  Of course, they have the possibility of substantial losses just like any other futures investment as well. But the times they struggle appear to be tied to times when there isn’t enough movement in stock index futures, not the other way around.

These systems are designed in such a way that they risk a relatively small amount (say $1,500) per trade in hopes of making a much higher amount (say $5,000) when they get the timing and direction right. So while the volatility can really help them, it doesn’t necessarily work both ways. That is, they aren’t at risk of losing oversized amounts because of the volatility. Their risk of loss remains tied to issuing the “wrong” trades many times in a row (or many more times than winning trades over a period of time), not to a single trade turning into a huge loser equal to 20% or more of the account (as we’ve seen with option sellers)

This design of risking a small amount in hopes of making a larger amount is also referred to as an option buying profile, as the purchaser of an option generally does the same thing of spending a little in hopes of making a lot. And we refer to option buyers in the opposite way we refer to option sellers – that they are long volatility traders. So, it only follows that if you’re looking for long volatility exposure, find the investments which have the risk a little to make a lot / long volatility setup, such as trading systems

Top Long Volatility Trading Systems:

> Compass SP – $30,000 minimum

The Old Faithful of trading systems, members of the Attain team have been tracking this S&P 500 futures day trading system for nearly 100 months (96). That’s longer than the track record of popular CTAs like Pere, APA Modified, and Crescent Bay combined. Most people are scared off by the program’s two losing years in 2004 and 2006, and the -82% DD which spanned from Nov. 2005 to March 2007.  But that DD and losing years coincided nearly perfectly with the period of extended low volatility. And once that volatility ended, in Feb 07, the program snapped back to its winning ways impressively.

Compass has a wickedly simplistic logic where it ignores all past price action, and only looks at the current day’s market activity. It measures whether the day is significantly strong or weak, and then puts in orders to get in line with that daily trend, if it exists. When such intraday trends hit the market, Compass likes to see follow through into the close in order to be successful. So a day such as today in which the market generally moved higher throughout the day and then closed on its highs would likely result in a Compass winner (days like last week when the market closed at its lows would also be likely winners – Compass doesn’t care whether the market rises or falls) Conversely, market action which sees the Dow up 200, down 300, up 100, and then finishing down 150 would likely result in a losing trade for Compass, as the trend didn’t continue on into the close.

As we’ve said many, many times in the past, Compass has the longest track record of actual fills for any publically available trading system we know of, and due in no small part to that lengthy experience, we recommend it as a component of nearly all portfolios. View the Compass System Spotlight here.

> AG Mechwarrior ES  – $15,000 minimum

A swing system we urged people with short volatility exposure to add after the volatility spike in Feb. of 2007, it has had its ups and downs, but remains a nice diversifier. It went through a DD even with volatile markets at the end of 2007, beginning of 2008 – showing that just being a long volatility program isn’t enough, but its rally back to new equity highs after hitting that DD is encouraging.  AG Mechwarrior works on 45 minute bars, thus gives the market a little more room to bounce around before heading in one direction or another, then exits on the first profitable close it sees. In this way, it is really a day trading system which will hold some positions over night from time to time if they are not going its direction sufficient enough.  View the AG Mechwarrior System Spotlight here.

> Beta Con 4/1 ESX - $5,000 minimum

One of the systems which are auto-executed by Attain’s partner in Spain with a direction connection to the Eurex exchange in Europe, this system’s equity curve looks like a near match of a chart showing the percent change in the VIX (volatility index), with impressive gains in 2002 and 2003, then flat performance for three years, followed by a nice breakout to the upside since mid-2007.  The system is a day trader which specializes in the Euro Stoxx futures, a market as liquid and voluminous as the emini SP futures in the US. The 4/1 in its name means it re-sets it parameters every 1 month, using the past 4 months of data to do so. There are several other Eurex based systems which look impressive in hypothetical backtesting, but we have been tracking actual fills for the Beta Con 4/1 eSX system since March 2007, and that gives us an extra bit of comfort than some of the other Eurex systems which have not gone through the actual trading gauntlet yet. At a minimum of just $5,000, it is hard not to consider this system for your portfolio as a cheap long volatility play. View the System Spotlight on Eurex systems here. :

> Waugh eRL – $10,000 minimum

Another system which has done very well amidst this recent bout of volatility, the Waugh system was designed by a client of Attain’s (Bruce Waugh) who still trades it for his own account.  The system trades the emini Russell 2000 futures, although we’ve also tested and run it on other stock indices. Similarly to Compass, Waugh eRL is a day trader which looks for a move in one direction at certain times of the day, and then looks for that move to continue into the close. View the Waugh eRL System Spotlight here.

What if the Trading System Drawdowns look to high for me?

The sometimes large drawdown levels seen in trading systems past performance is often a concern for many investors who are looking at allocating some money to futures trading systems. These larger drawdowns are the result of trading systems being less flexible than CTAs. The trading systems do not have a manager overseeing each trade. They don’t have a manager who can decrease the number of contracts if we enter a low volatility period, etc; and that shows up in higher drawdowns over the life of a system as the track record shows the good, bad, and ugly of that system across many different environments.

But there are a few things investors can do to lower the effective drawdown of any system (or CTA for that matter) they are considering. One simple way to lower the worst possible drawdown you might experience is to time your entry into a trading system allocation. Instead of just jumping into Compass for example, and being at risk of seeing another 80% DD, wait for the system to have a 20%, 30%, or 40% DD. In waiting for one of those DDs, you can effectively remove that amount from the max DD you will have to incur moving forward. So you set -80% as the stop trade point, and get in at -40%, the real DD you are risking is just 40% (half of the past worst case scenario).

Another way to potentially lower the DD is to be your own portfolio manager. If part of the reason trading systems see larger DDs is because no one is actively managing it, then actively manage it yourself. A savvy investor could potentially lower the max DD by getting out of a system if the volatility goes back to the low levels seen in 2005, or instructing Attain to not trade on holiday weeks, or similar scenarios. The best thing to do in our opinion is usually to stick with a system until it goes through your predetermined stop trade point, and not try and start/stop a system; but that’s not to say it couldn’t work to your advantage.

The Time is Now for Trading Systems

In conclusion, this is an unprecedented time in the financial markets of the world, and there may be no better way to capitalize on these highly volatile times than allocating to one of the above futures trading systems which have a long volatility profile and have proven to do well in this environment. If you are looking for what has been working (with the obligatory disclaimer that past performance is not necessarily indicative of future results), than you may not need to look any further than day and swing trading systems.

- Jeff Eizenberg


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Feature | Week In Review: Worldwide panic subsides some as markets rebound off lows | Chart of the Week


Last week again provided plenty of volatility in all types of markets, but there appeared to be a subsiding of fear as the wild swings became almost “normal”.  A concerted effort of foreign governments to thaw a frozen credit facility also helped, but ideas that a global recession is coming continued to keep investor confidence low in most commodities as evident by the continued weakness in the CRB index -7.98%. The metals were the largest moving component in the CRB index led by Platinum -12.46%, Silver -11.94%, Palladium -11.75% and Gold -8.41%. Copper did post gains +1.71% on news that stock levels had been reduced a bit versus earlier forecasts.

The energy sector was again punished by recessionary fears and ideas that the current world supply/demand situation was near equilibrium. RBOB Gas -9.67% led the declines followed by Crude Oil -7.62% and Heating Oil -3.97%. Natural Gas +2.86% found support from ideas that supplies will start to drawdown ahead of the winter heating months.      

The stock index sector did see some gains despite severe volatility with support stemming from the unity of foreign governments to inject liquidity into credit market. Activity was all the more impressive given some U.S. economic reports showed weakness, especially Housing Starts which were reported at an 18-year low for the latest month. Dow futures +4.68% led the way followed by the S&P 500 futures +4.66% and NASDAQ futures +2.28%. The small cap sector was near steady for the week.      

Most currencies ended the week lower with the exception being the British Pound +1.18% as it found support from higher yielding interest rates via the LIBOR. The Japanese Yen -1.55% led the way down with most other currencies posting nominal losses. U.S. rate futures also ended with loses as nervousness about the credit sector and the effectiveness of a possible unified rescue plan kept the sector on edge. For the week U.S. 30-year Bonds lost -2.85% and 10-year notes ended -1.77% lower.

The commodity and food sectors posted mixed results last week with some areas finding support from demand sparked by the recent sharp sell off. Despite some support on bargain hunting continued pressure from credit issues hampered import/export results leading to larger than expected supplies. The grains ended mixed as Corn was up +1.59%, Soybeans -1.86% and Wheat -.57% were lower. Livestock saw Live Cattle up +1.39% and Lean Hogs down -6.26%. Cotton +5.96% and OJ +8.98% were the gainers in the soft sector. While Cocoa -5.54% and Coffee down slightly remained under the weather.     


Multi – Market trend following managers continue to have success in October.    Downward trends across many of the commodity sectors, foreign currencies & stock index futures continue to be profitable for managers with short positions. US stocks did rebound slightly last week as the brunt of the credit crisis seems to have finally passed the market by.  However, it is far too early to assess the damage inflicted by the frozen credit markets and many still believe that the worst is yet to come in terms of a recession and deflationary economic environment.  Managed futures, specifically multi-market trend following managers, are designed to perform well in these market conditions and continue to be a great diversification tool for individual investment portfolios.

Thus far in October our own Attain Portfolio Advisors Modified Program continues to perform well and leads the pack of profitable managers with estimated returns of +15% in October.  The larger APA Strategic Diversification Program has also done well with estimated returns of +6% this month.   Both programs have benefited from APA’s multi-diversification model, which looks to capitalize on moves as short as a few hours up to multi-month moves.  

Not far behind APA is the Dighton USA SWISS Futures program which is up +6.31% (est) after profitable trades in the stock index and energy sectors.   Other traders that have done well in October include Robinson-Langley +5.27% (est), Long Term Trading Navigator +3.36% (est) and Hoffman Asset +3.04% (est).   

Other managers posting gains include Northside Trading with returns of +1.20% (est) and DMH is also in the black with gains of +0.53% (est).   Meanwhile, Clarke Capital has been quiet this month with no trades and is at even in both their Global Basic and Global Magnum programs.

Amongst option selling CTAs, record highs in volatility last week (the VIX hit 80) sent most stock index option selling CTA's to the sidelines to lick their wounds while markets work to figure out where to go from here.  Option selling estimates for October are as follows: ACE -26.65%, Ascendant S1 -31.62%, Cervino Diversified -4.7%, Cervino Diversified 2x -9.36%, Crescent Bay PSI -9.24%, Crescent Bay BVP -9%, FCI -25%, LJM Partners -65%, Rathiel -7.92%, Zenith Index -9.24%, and Zenith Diversified -13.23%.

There is no doubt that October 2008 has been the most volatile month in recent history – and it should act as a loud and clear real-time warning to diversify one’s CTA investments into long volatility mangers as well.

Rounding out the CTA strategy types, Agriculture CTA's have seen mixed results so far in October.  Leading the way MTD has been NDX Abednego and NDX Shadrach with estimated gains of +1.16% and +1.36% respectively - NDX has been this years "sleeper CTA" with impressive YTD returns.  Through September Abednego was ahead +19.07% and Shadrach is ahead +55.90%.  Elsewhere for the month, Chicago Capital is down -3.74% and Rosetta is down aprox 9%.

***Trading Systems***

The continued volatility in global stock indices continues to benefit day and swing trading systems thanks to their long volatility profile, but it not a place for the feint of heart. With daily ranges of 100+ in the S&P and 1000+ in the Dow (which would be big monthly moves) quick losses and potentially large gains have become the norm.

Day trading systems came through in a big way last week with two systems returning over $5K on a single contract basis. Rayo Plus Dax was the top performer with a staggering +$18,063.78 on three trades from early in the week. Monday’s trade was on the long side when global equities rallied over 10 %, and then followed it up with two short trades on Tuesday and Wednesday. Compass SP was quiet last week with only one trade, but it made the most of its chance, pocketing +$5,125 and put the system at +125 % for the year (based on $30K initial balance). BetaCon 4/1 ESX also had a breakout week +$3,129.44 on three trades. Finally, Waugh eRL traded four times for +$1,998.

On the losing side, BounceMOC eMD lost -$710 on a long trade from Monday that was stopped out before the broader market made another push higher late in the day.

Moving on the swing systems, the Tzar suite of systems are well positioned on the short side but gave but gave back some open trade equity as the ES, NQ and eRL moved higher throughout the week. Bounce eMD had a similar result to its day trading counter-part -$753.33. Signum EBL continues to hold long and gave back some open trade equity as bond prices fell globally throughout the week. Ultramini ES traded twice last week for +$880.

In long-term trading, commodity markets have slowly started to rebound but most programs are far from exiting short positions across energy, metals and grains. Last weeks decline in global bond prices forced many programs to exit their long positions.

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.