 |
“E-trading is a wonderful thing but it has led to huge intra-day swings due to increased speculator volume” |
“It was Pirates of Profit or Merciless Mercenaries. But the latter was a bit of a mouthful,” jokes Paul Brittain, the founder of CTA Pirates of Profit, when explaining the unusual choice of name. Brittain maintains a sense of humour but the present market environment has had serious consequences for Pirates of Profit, which follows a strategy dependent on low to moderate volatility in the commodities markets. In January, Brittain was forced to stop trading, and is now waiting on the sidelines. Brittain registered the independent CTA in June 2006, having run the strategy on a broker-assisted basis for several years, averaging monthly returns of about 4% to 6%. “We were selling strangles and up to that point it had been easy to do – almost too easy.” Shorting strangles is essentially selling an out-of-the-money call and an out-of-the-money put in the same stock or commodity with the same expiration. If the underlying commodity moves little (stays within the strike prices of the short options), then the CTA benefits.
Bad timing
“Unfortunately, it was bad timing. We registered the fund with the NFA and began trading for investors in 2006 but then volatility started to creep back in. We ended up down at the 2006 year-end by about 2%,” says Brittain. In 2007, volatility increased further with market uncertainty. “E-trading is a wonderful thing but it has led to huge intra-day swings due to increased speculator volume,” he says. “Commissions that used to cost $100 now cost $2 and commodities are being traded around the clock. The swings are not necessarily bigger in terms of percentages but when the markets are high, those swings are harder.”
Fortunately, says Brittain, most investors withdrew their money from the CTA during 2007 as they sought higher returns elsewhere. The fund lost 20% over the year. “By the end of 2007 most of the investors’ money had been withdrawn. It was a blessing in disguise. We were left with only about a half a million in assets under management by the end of October, and money continued to leave. Then, in the middle of January this year, we lost 60% in a few short days. It was a disaster, but luckily by that point we had barely any third-party money invested.” There was simply no choice but to stop trading until volatility decreases. Brittain doesn’t expect that to be soon.
“It’s the worst environment I have yet to witness as an options trader,” Brittain says. “The 1987 crash was over in a day, the 1998 crash was relatively quick and even in the early 2000s the sell-off was relatively normal. But the S&P 500 has been going up and mainly down since October and an end is still not in sight. The market needs to digest the fact that the stock market has been going up and up for years. We think lows will be in the 1160 to 1180 mark, and that will come in the next six months to a year. Until then we will wait on the sidelines for the options market to swing back in our favour. Then we’ll put our flag back up and start sailing.” On the plus side, Brittain says that margins in futures trading have been largely unaffected by the credit crunch. “The price of crude oil has gone up five times since 2002 while margins have only a little more than doubled.”
Educate investors
Brittain is still upbeat largely because of his longstanding experience of markets and understanding of the risks involved in trading commodities futures and options. It is not always the case. Brittain is manager of Alaron Las Vegas, a branch of commodities broker Alaron, which is headquartered in Chicago and is one of the top 40 largest futures commissions merchants in the US. Alongside Brittain, the assistant manager of Alaron Las Vegas, Carley Garner, runs an online education programme for commodities traders. Although volatility has not proved right for Pirates of Profit’s strategy, commodities are experiencing a bull run and speculators are becoming more numerous. Alaron’s interactive courses are free online and updated daily. Since inception in 2004 more than 15,000 students worldwide have enrolled. “Obviously we hope that by Alaron providing a high quality of education in commodities trading, students will use it as a broker when they trade,” says Garner, pointing out that such use is not obligatory. “But equally important for a broker like Alaron is trying to educate traders. The market will benefit from having traders who understand the risks and the technicalities of trading commodities.” Garner says students range from long-term traders who sign up for a few courses to individuals entirely new to trading. In particular, she says that grains and metals, particularly gold, are seeing greater trading activity from hedge funds and CTAs looking for investment opportunities. But, she warns, increased interest has pushed prices to highs that might well not be sustainable in grain and gold.
Garner and Brittain’s book, Optionology 101, an A-Z of options trading, will be published in mid-2008.
