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CTA Spotlight: Argus Capital Management

October 16, 2006

 

In addition to our monthly "System Spotlight"s, the Attain Alternatives newsletter will include a CTA spotlight from time to time. For a quick refresher, CTA stands for Commodity Trading Advisor. CTAs are professional commodity traders who manage accounts for individuals and institutions, and usually charge a 1%-3% annual management fee as well as 15% to 30% incentive fee — which is a share of the profits.

Some of the best performing CTAs over the past three years have been option sellers who have taken advantage of the historically low volatility in US stock indices over that time. The poster child for these successful option selling CTAs had been Zenith Resources - currently working on their 37th consecutive winning month. But Zenith became so successful that they had to close to new investors in September to protect their execution and returns for the current investors.

Many investors have asked who the next Zenith might be - in terms of both success and the possibility of closing their doors. Past performance is not necessarily indicative of future results, but with returns of over 50% in 2005 and over 40% so far in 2006, and a ten fold increase in assets under management so far this year — a leading candidate is the topic of our CTA Spotlight: Argus Capital Management.

Who is the Manager?

The manager of the Argus Capital Management CTA is Steve Zielinski of Metuchen, New Jersey.

Mr. Zielinski's interest in trading commodity futures (and options on those futures, in this case) began nearly 20 years ago in much the same way it does for many traders - he got a taste of success trading on his own. While he was in a completely different field, managing some local restaurants, Steve officially had the "trading bug" and decided to become a futures broker.

Mr. Zielinski has been active in the futures industry ever since making that decision to become a futures broker in 1999, working his way up the ladder at a New Jersey futures brokerage firm as a registered futures broker, first assisting in the opening of futures accounts and later working directly with customers.

During this time as a broker, Steve learned his way around options prices, spreads, and risk - all the while coming up with what would later become the Argus program for selling limited risk credit spreads.

Feeling comfortable with the knowledge he had acquired, but wanting to move in a new direction which would allow him to manage accounts using this strategy - Steve left to start his own brokerage firm with partner Christopher Corvo in 2004. The new firm was called Mercury Capital Management.

Mercury has success in gathering clients, and in January of 2005, Mr. Zielinski began managing a firm account using the program. After good success, Argus Capital was formed shortly thereafter and began trading customer accounts in November of 2005.

Steve lives in New jersey with his wife and four children, and enjoys snow skiing and his newest hobby - viticulture, or enology as some call it, which is the study of grapes and wine making.

How does the Program Work?

The Argus program specializes in limited risk credit spreads on S&P 500 futures options. 'Credit spreads' is just another way of saying they sell options with the hope of keeping all of the premium paid by the option buyer. And the 'Limited risk' part is just another way of saying that you can only lose a set amount on each trade, as compared with naked short options, which have unlimited risk.

A credit spread consists of two options of the same type (2 calls or 2 puts) and the same contract month expiration. You sell one option at a particular strike price, which you collect premium for, and you buy another cheaper option at the same time. This limits your risk on the option you sold. Because you are selling a more expensive premium option than the one you are buying, you take in a credit. Your risk is the difference between the two strike prices, less the net premium you collected, plus commission and fees for placing the trade. By placing the trade as a spread, you never expose yourself to unlimited risk.

Argus has a slight bearish bias in the program, which means they are more often than not focused on selling the call side of the market (selling calls is a bearish bet). The typical difference in the strike prices between the sell and buy side options is 25 points, while Argus targets a credit of 4 to 5 points. That means the strategy is risking $6,250 in order to make just $1,250.

That would not seem to make much sense to most people, but when you consider Argus' trades are profitable about 85% of the time, and that the average loss is just 2-3 times the premium collected, not the full 25 point risk that would only happen in a big, Black Monday type of market move, laying those types of odds starts to seem logical.

Trade Example:

July 26th: S&P Futures market Price = 1275

Sell 4 August S&P 500 Futures 1350 Calls @ 2.00 per Call = Credit of $2000

Buy 4 August S&P 500 Futures 1375 Calls @ .75 per Call = Cost of $750

Total Credit of $2000 - $750 = $1250

August 18th: S&P Futures market Price = 1307

Both sets of Calls Expire Worthless, effectively buying them back at $0

Gain on Trade = $2000 Credit – $750 Cost - $15 commission*8 = $1130

$1130 = +2.26% on $50K minimum investment.

To further control risk, Argus will not concentrate all of an investor's capital in a single credit spread. The program spreads trades out between different options months, with 60% of trades in the front month contract, 25% in options two months out, and 15% in 3 month out options (i.e - the option expiration is in 3 months). Argus uses a proprietary indicator to place trading range bands around the current market prices, and when selling call spreads: front month options are placed 3-5% outside of the upper band, second month options are placed 5-7% outside of the upper band, and third month options are typically placed 10% outside of the upper band of the current market range.

The number of spreads in a trading account is limited to the percentage of total equity in an account less allowable margin on the trade. In determining the types of option spreads to sell, Argus Capital needs to analyze a wealth of information. Argus Capital needs to consider criteria such as the current market range; the amount of time to expiration; the dollar amount of how far the out-of-the-money of option spread is; and fundamental and technical indicators.

As a final risk control, Argus puts a 30% loss stop trade point on each account, whereby if any account reaches a loss of 30% he will suspend trading.

Attain Comments:

Argus is the top ranked CTA at Attain by Sterling Ratio (click here to see rankings), which is a risk adjusted performance ratio that measures average annual returns over average annual drawdowns. Investors use ratios such as the Sterling to compare different investments, as it is not always readily apparent whether a program with twice the returns but twice the DD of another program, for example, is better or worse in terms of return per unit of risk. In this case, Argus ranking tops among CTAs in Sterling ratio tells us that while the DD for Argus is a little higher than other option selling CTAs like Zenith, their higher returns more than make up for it relatively speaking.

One feature we particularly like about Argus is their slightly bearish slant and choice to mainly use credit spreads on the call side. Because Argus favors call options, and is apt to do poorly if the market spikes upwards, I view this as an excellent diversification tool to an overall portfolio which should do well when the market spikes upwards. In plain words, its' pretty easy to live with your alternative investment suffering when your normal investments (long buy & hold stock positions in mutual funds, IRAs, 401Ks, etc.) are doing well - and it doing well when the general market is going lower.

In very general terms, Argus will do quite well if we continue to be in a trading range, and will suffer when we see quick, successive moves to the upside. This is evident in the track record, where his two worst months, July 2005 and November 2005 were also the two best performing months for the S&P 500 in the last 16 months. (+3.72% and +3.78%). It's also worth noting that Argus is in the midst of drawdown right now as the market has had another move higher.

Many investors have asked us why the returns for Argus are significantly higher than other option selling programs, thinking that covered writing would produce lower gains than naked, as there is limited risk versus unlimited risk. The answer to that lies in Argus' trades lying much closer to the market than a strategy like Zenith, and as a result the inside option that is sold is typically worth 2-4x that of the outside buy. So Argus is getting about 3-5 times more premium per position, and in doing so can make about 3-4 times more.

Now, there is additional short term risk associated with the spreads being closer to the market, and investor's should be prepared for a more volatile ride with Argus than those option sellers that merely sell insurance against another Black Monday event. But in the same breath, the worst case scenario for Argus is only the difference between the spread prices, while theoretically unlimited elsewhere. So while Argus may have some higher short term risk, it has, by definition, lower long term risk in that a Black Monday won't completely wipe out the account. This added short term risk has meant higher profits for Argus, and we believe it can continue.

- Jeff Malec