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Mistakes Being Repeated / A Picture Into The Amaranth Failure From Natural Gas

|Includes:Bill Barrett Corporation (BBG), BTUUQ, CHK, COG, DVN, ECA, EQT, FST, GS, KWK, NFX, QEP, RRC, SPY, SWN, UNG, UPLMQ, WPX, XCO, XEC

Mistakes Being Repeated / A Picture Into the Amaranth Failure from Natural Gas

We should look to our past to understand the future, and when it comes to current natural gas variables we see danger signs.

To quote directly from Chincarini's (2008) article titled "A Case Study on Risk Management: Lessons from the Collapse of Amaranth Advisors L.L.C." published in the Journal of Applied Finance:

"In September. 2006, a large-sized hedge fund named Amaranth Advisors LLC lost $4.942 billion in natural gas futures trading and was forced to close their hedge fund. Although Amaranth Advisors was not exclusively an energy trading fund, the energy portion of their portfolio had slowly grown to represent 80% of the performance attribution of the fund (Source: Senate Subcommittee Exhibit #12). Their collapse was not entirely unforeseeable or unavoidable. Amaranth had amassed very large positions on both the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (NYSE:ICE) in natural gas futures, swaps, and options. The trades consisted mainly of buying and selling natural gas futures contracts with a variety of maturity dates. Their trades were very risky from both a market risk perspective and a liquidity perspective."

"Since the collapse of Amaranth, several authors have attempted to understand what positions and risk levels Amaranth was engaged in to cause such a dramatic collapse

{Chincarini. (2006) and Till, (2006). Chincarini (2006) used the information from newspapers, CEO statements, and actual natural gas futures data to quantify the nature of the most likely trades that were made at Amaranth. That paper hypothesized that Amaranth had engaged in a short summer, long winter natural gas trade primarily using natural gas futures. Based on these backward-engineered positions, the paper examined

both the market and liquidity risk of Amaranth's positions prior to its collapse."

[continued to]

"In September 2006, the natural gas futures markets behaved entirely different than it had historically…..One can see, from this figure, the dramatic negative returns in September, which were as low as -27% for front-month contracts."

(please read entire article should you choose to)

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Just a little refresh of how history has giveth and taketh….

Amaranth = $5 billion lost in one week!!!

happy trading!

Reference:

Chincarini's Ludwig (2008) "A Case Study on Risk Management: Lessons from the Collapse of Amaranth Advisors L.L.C." Journal of Applied Finance:

Disclosure: I am short UNG.

Additional disclosure: Short natural gas.

Stocks: BBG, BTUUQ, CHK, COG, DVN, ECA, EQT, FST, KWK, NFX, QEP, RRC, SWN, UNG, UPLMQ, WPX, XCO, XEC, SPY, GS