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CTA Spotlight: Zephyr Asset Management

July 10, 2006

 

With many Attain clients enjoying success in the popular Zenith Resources option selling program so far this year, the call for Attain to find more managers successfully using option selling strategies has gone out.

The result - Attain has forged a relationship with Zephyr Asset Management - one of the top up and coming CTAs (Commodity Trading Advisor) in the country. While Zephyr isn't new in terms of time - having a track record which goes back to 2003 - they are new in terms of dollar under management, with under $10 Million.

Investors often love finding successful managers with less than $10 MM under management, as successful managers don't stay under $10 Million for long. The reason - their success leads to more money under management, and once they get into the tens of millions, institutional money can start pouring in and quickly close a successful program to new investments.

This quarter's CTA spotlight is on Zephyr Asset Management. For more information, visit www.zephyrasset.com.

Who is the Advisor?

The financial world is full of prodigies who have gone on to launch their own successful firms, and the managing directors of Zephyr Asset Management cut their teeth with some of the finest option selling managers in the world.

The managing directors of Zephyr Asset Management are Kevin MacLean and Joseph Natoli. Kevin ad Joe started working together in August of 2004 when they formed Zephyr, but have both been in and around the option selling game for quite some time.

Kevin worked on the floor of the Chicago Mercantile Exchange from 1992 until April 2003, working on the Bear Stearns Options Desk and with Fimat USA/Societe Generale before establishing his own trading desk specializing in S&P futures options. Some of the firms executing their trades through Mr. MacLean's desk included option selling CTA firms Ansbacher investment Management, Inc. and ACE Investment Strategists, who now have close to $300 Million under management between them.

Mr. Natoli also earned his stripes under the watch of Yu Dee Chang, the principal of ACE Investment Strategists, LLC. Joe was the Trading Desk Manager responsible for 20 million dollars in client assets at Chesapeake Investment Services, the brokerage firm which executes all of the ACE program's trades. Mr. Natoli left the firm in May of 2003 to begin trading private client funds, and joined forces with Mr. MacLean to form Zephyr Asset in August of 2004.

Mr. MacLean lives in Nashville, TN on an old working farm with his wife, while Mr. Natoli resides just outside of Annapolis, MD on Chesapeake Bay with his wife and two children.

How does it Work?

Zephyr Asset Management has two programs, the Aggressive and Moderate programs which both specialize in collecting premium through the sale of S&P futures options. In this regard, Zephyr is in the same category as the popular Zenith and ACE programs which also sell S&P futures options.

One of the main differences between Zephyr and the other option sellers is Zephyr's flexibility due to its more active "trading" of its positions. There is continuous monitoring of positions in relationship to the price movement of the market, volatility and economic and political developments, both here in the United States and abroad. Flexibility allows Zephyr to change the trading range whenever it becomes advantageous or necessary. This is always done at the end of expiration but can also be done mid expiration if the conditions merit.

To put this flexibility in numerical terms - Zephyr estimates that only 25% of their short option positions options expire worthless versus approximately 90% with most other option selling managers. So where another option selling CTA may sell an option to take in 1.50 points ($375) in premium then wait til the option expires worthless - Zephyr is more apt to buy that short position back at 0.30 points ($75) for example.

The longer any investment is "in the market", the longer it is at risk, and Zephyr's approach is to reduce that risk by getting out of the position. When there is just $75 left to make on the position, you can't blame them for not wanting to risk tens of thousands of dollars to make less than $100.

To determine where to sell the calls and puts (strangle) on the market, Zephyr uses a mix of fundamental and technical analysis to gauge the current trading range. In essence, they are trying to determine where the market will not go.

Call and put options are sold at different strike prices above and below the predicted trading range. This is called an option strangle, as you don't want the market to go outside of the area you are "strangling" with your calls on one side and puts on the other. Short positions are generally put on within 15 to 60 days of expiration. If the market remains within the expected range and does not produce a strong move in either direction then the options sold will expire worthless.

In the event the market makes a strong move in one direction then it might be necessary to buy back the option before expiration. The strongest determining factor is time. The farther away the positions are from expiration, the more likely they will be to cover the option at a loss. Several other reason for covering the position include to protect profits, to increase the profit potential for the next expiration period, to avoid or minimize a likely loss, or to free up margin to take advantage of a different opportunity.

Finally - Zephyr employs a disaster plan by which they place stop orders in the S&P futures which are slightly higher than the strike price of the options they currently hold if the market moves with one limit down move of their current positions strike prices on a 1:1 protection basis. This protects investors from a severe down move which could see the S&P futures "locked" limit down for several days in a row. In such a scenario, the stop orders could get executed, leaving the short futures positions offsetting the losing options positions.

Zephyr offers two separate programs - the first program is called the Aggressive Program and it is the most aggressive with a goal of returning 25% - 35% per year, and the second program is called the Moderate Program and is less aggressive, with a goal of returning 20% - 30% per year.

Attain Comments

Two things we like to see in an option seller is 1) How did they do during times of market stress and volatility spikes and 2) how have they done during the declining volatility environment the last two years.

Zephyr has done well on both accounts. While we would love to have seen how the program reacted during the 9/11 terrorist accounts, their track record does include something similar with the London bombings in July of 2005 representing a big volatility spike. The July 7th terrorist bombings in London sent futures severely lower overnight - and options prices shot higher as the volatility increased dramatically. Zephyr actually put on the wrong positions at just about the worst time (selling calls on the market open - thinking prices would go lower), but escaped the month with a very manageable loss of just -1.8% in the Aggressive Program.

One possible red flag with option sellers is their performance during the last two years as volatility has steadily declined. While it may sound counterintuitive, an option seller that has had 'as good' or 'better' performance in 2004 and 2005 versus 2002 and 2003 would signal that manger has been taking on too much relative risk during the past two years to keep their performance up.

Zephyr's performance during the past two years has remained in line with what we would expect with the declining volatility, signaling to Attain that the manager has stuck to their guns, remained systematic, and not taken on extra risk to achieve their goals.

In the end - the ability to get involved with a professional CTA for as little as $50,000 is appealing - with most advisors with track records over 6 years and over $20 Million under management requiring initial investments in the millions.

- Jeff Malec