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The hottest game in town: S&P 500 Option Selling CTAs

January 4, 2006

How do you make money in this market? Well, nobody knows for sure, and past performance is not necessarily indicative of future results, but if you're one of the fastest growing investment segments in the managed futures industry - you sell options, also know as selling volatility. And with volatility at historically low levels, it makes a lot of sense that those CTAs who are selling volatility have become one of the hottest games in town.

For a quick refresher, CTA stands for Commodity Trading Advisor. CTAs manage accounts for individuals and institutions, and usually charge a 1%-3% annual management fee as well as 15% to 30% incentive fee - or share of the profits.

So what are these option selling CTAs doing that's so special? The answer to the first question is that they are profiting from the inherent time value decay in options. When you sell an option, and all else is held equal, the price of that option will decline to zero by the expiration date. You've most likely heard the old saying that 90% of options expire worthless, and while we're not interest in whether or not that statistic is true - you get the idea - that a lot of options end up being worth nothing, nada, zilch.

All of these advisors are attempting to profit from this time decay property of options in one manner or another, whether it be selling naked call or puts, selling bear credit spreads, or selling bull and bear credit spreads simultaneously - an "Iron Condor". The question of how these advisors and their strategies differ seems to come up more with different option selling strategies than anything else, and it is important to note that these are merely using option selling as their investment vehicle, and the different strategies and methods of getting into and out of positions (and when to get in and out) are what really add value and create the performance.

As one of our clients said, "anyone can sell options", and this difference may seem small, between the tool (options selling) and the method (where and when to sell them). But just imagine yourself at the plate trying to hit a 95 mph fastball, versus what Hank Aaron or Mickey Mantle could do in the same situation, and you can see that the tool (the bat) is not as important as the skill using it.

These advisors skill in using the "bat" is based on where and when they sell their options. Some sell them much closer to the market than others, and in doing so generate higher profit, but with higher risk. Some have theoretically unlimited risk with naked writing of options, while others prefer spreads which insure the loss is no more than the difference between strike prices.

So how can you tell all of these different option selling CTAs apart? As always, we're glad you asked - and have created the following table for help in seeing each of these option selling CTAs side by side.

Option Seller Comparison:

Past Performance is Not Necessarily Indicative of Future Results

CTA	Avg Ann RoR	Max-DD Month-End	Sharpe Ratio	Assets Managed	Option Strategy
ACE Investment Strategists	59.20%	-7.80%	2.50	$105 Million	Short Strangle/ Naked Writing
Argus Capital	46.42%	-13.42%	2.04	$13 Million	Bull/Bear Credit Spreads
Outrigger Asset	25.63%	-12.63%	1.90	$20 Million	Iron Condors
World Capital, Inc	25.52%	-4.25%	2.47	$20 Million	Iron Condors
Zephyr Asset (Moderate)	24.76%	-2.99%	3.23	$10 Million	Short Strangle/ Naked Writing
Zephyr Asset (Aggressive)	32.72%	-3.99%	3.79	$12 Million	Short Strangle/ Naked Writing
Zenith Resources Diversified	21.70%	-0.00%	7.26	$25 Million	Naked Writing/ Credit Spread
Zenith Resources Index	26.47%	-3.12%	3.40	$90 Million	Naked Writing

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.

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The Week in Review: Good month to be long, no matter the market

***Overview***

November was good month to be long, no matter which markets you prefer to speculate in — as nearly every asset moved higher in November. In equity trading US Stocks continued their slow but steady rally as the US economy has proven to be very b and resilient. Perhaps this was the annual "Santa Claus rally" a month early, however. For the month SP futures gained +1.42%, NASDAQ futures were up +2.98%, Russell 2000 futures rallied +2.14%, and SP Midcap 400 futures moved +2.75% higher for the month.

Much like stock traders, US bond traders have also had their eyes on the economy in an attempt to predict exactly whether or not the Fed will raise interest rates in the near future. Right now all signs are pointing towards no as the US economy keeps chugging along and inflation indicators have stabilized. Thirty year bond futures reacted positively to various job & inflation related economic reports in November and gained a total of +1.53% for the month, while 10 year note futures were up +0.82%.

The surprise move of the month belonged to the US Dollar and its foreign currency counterparts. As US traders dined on turkey over Thanksgiving, overseas traders were selling Dollars and loading up on Euros. Most of the movement was a result of speculation by European analysts and traders that the US economy is not as b as it appears, causing the US Dollar to lose value at a rapid pace over the last week of the month. Overall, for the month the greenback was down -2.66% while the Euro was up +3.63%, the Swiss Franc gained +3.45%, and the Japanese Yen moved +0.56% higher.

Energies rebounded in November despite relatively mild temperatures across the US. Most of the rise in energy prices can be attributed to continued speculation that OPEC is going to cut production relatively soon. Crude Oil futures gaining +4.12% in November, RBOB Gas futures were up 11.72%, Natural Gas futures climbed +10.15%, and Heating Oil futures moved +7.33% higher.

Finally, most commodity markets enjoyed rallies in November as well. Grains led the charge with Corn futures gaining +16.05%, Soybeans were up +6.40%, and Wheat futures moved +3.57% higher. Metals also enjoyed rallies with Silver futures gaining +13.31%, Gold was up +6.47%, while Platinum +8.24% and Palladium +1.94% also traded higher. High Grade Copper did not follow suit however losing -5.42% for the month. In the tropical markets Sugar gained +7.10% and Coffee was up 10.64%, cotton finished the month unchanged. Finally, meats were the only commodity sector to move lower with Lean Hog futures losing -4.37% and Live Cattle futures dropping -2.14%.

***CTA Trading***

November saw several of thediversified CTAâ€™s who don't operate in the option selling space rise abruptly to the top of the performance charts. Attain's own Strategic Diversification program gained over 4% in Nov. to hit new all time highs, while the discretionary CTA Dighton had gains of over 15% in November for yearly gains of +46% with one month to go. This shift was attributed to the recent up trends in the grain markets, down trends in energies, and weakness of the US Dollar. 4th quarter run ups in the multi-market, trend following CTAâ€™s is something we have observed in each of the last 4 years.

Beyond the multi-market CTAs, most of the option selling CTAs posted "normal" monthly gains between 0% and 2%. One big exception to that was the Argus program, which continues to struggle through the exact market environment it does worst in (a consistent, slowly rising market). Argus gave back about 15% in November.

Looking ahead to December, we have seen a pick up in market volatility since the mid-term elections in the US, and as a result option selling investors can expect to see the level of activity by the managers pick upâ€¦stay tuned to your accounts for the most up to date activity.

***Day & Swing Trading***

It wasnâ€™t all smooth sailing in the month of November, but the continued bull trend in stocks benefited the swing trading systems, for the most part; while the intermittent corrections paved way to some day trading profits.

Swing systems operate on multiple time frames but the common thread for profitable systems in November was holding long positions in stocks, bonds and currencies. SC Forex GBPUSD was the top performing swing system for November with profits of $5,350. The majority of the profits came from a long trade that exited just before the Thanksgiving holiday on the surge in foreign currencies. Mesa Notes was close behind with profits of +$2,345.31 after reversing to long early in the month. Delphi EURUSD also was able to profit +$1,650 in the FX market despite getting caught up in some choppy conditions around mid-month.

Some systems, like Spartan ES and SeasonalST eRL/ES, held long equities the entire month - while others like Axiom eMD and Adaptive US entered and exited several long positions throughout the month. Both strategies were roughly equal in total profits with Adaptive US making +$2,274, Axiom eMD +$1,806, Seasonal eRL +$1,490, Delphi eRL +$1,417.50, Spartan +$987.50, Delphi eMD +$960.50 and SeasonalST ES +$827.50. Bounce eRL and eMD each had one trade late in the month for small profits of +$80 and +$65 respectively.

Swings systems utilizing a counter-trend strategy such as the Tzar suite of systems didnâ€™t have the same success as those previously mentioned. Tzar ES made +$2.50 while Tzar NQ and eRL lost -$970 and -$1,302 respectively. The good news is that all of the Tzar systems reversed to long by the end of the month and are positioned for a year-end rally. Adaptive Euro portfolio really canâ€™t be described as counter-trend but the system struggled with direction and lost -$2,707.13 in November.

In day trading, BWT Zones Classic put together a stellar month with profits of +$4,225 - by far the most active and aggressive system. Phi Plus Dax continues to fight its way out of drawdown and tacked on +$1,641.36 for the month. Impetus eRL continues to be one of most consistent programs in â€™06 and added profits of +$543.80 for the month. Bounce eMD MOC and eRL MOC made +$276.60 and +$155.70 on one trade late in the month. Both Bounce MOC (day trading) and Bounce (swing) enter trades using the same logic but the swing system can and will hold positions overnight hence the reason for different results this month.

For the most part, losses in the day trading systems were contained. BetaCon ESX dropped -$96.54, Omega3 v1 Dax -$349, Compass SP -$350, BetaCon 4/1 Dax -$625.61, Tanker CL -$900, Epsilon Bund -$929.48, Rayo Plus Dax -$1,759.49 and Beta v2 Dax -$3,179.14.

***Long Term***

The past month had a little of everything as trending moves continued in the Grains, Energies and Interest Rates. Market pundit opinions on the welfare of world economies led to changes in the direction of currencies and sparked an upside breakout in the metals. Other sectors like the livestock and soft commodities remain fixed in choppy sideways trading ranges which, from a historic norm will probably not change as 2006 winds down.

The grain markets, especially the corn - gaining nearly 15% - continued their run as the leading capital gainers for long term systems in November. Systems holding long positions in corn include Aberration +$4250.00 (open trade), Andromeda +$3562.50 (open trade) Axiom LT +$5187.50 per contract (open trade) and Trend Simplicity with +$3450.00 (open trade). Vivaldi closed out a long soybean trade with a nice gain of +$3875.00 per contract.

The interest rate sector moved forward with the current uptrend as most terms headed to the highest levels since January 2006. Systems with long Bond positions include Andromeda making +$4662.00 per contract, Vivaldi making +$3009.00 per contract, Pegasus making +$1416.00 per contract, and Trend Simplicity +$822.00.

Notable trades (both good and bad) from November include Andromeda exiting a short Japanese Yen trade for profits of +$5393.75 per contract and exited short Swiss Franc for a loss of -$262.50 per contract. Aberration exited short Swiss Franc for a loss of -$4437.50 and mini Crude Oil for a gain of +$6375 per contract, while Andromeda also exited Crude Oil for a nice gain of +$14160.00 per contract. Finally, Trend Simplicity exited long crude oil for a gain of +$14100.00 per contract, but did give some back closing out a short Copper trade with a -$1800 loss and a short Live Cattle trade with a loss of -$ 600.00 per contract.

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