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6.5 Thoughts on a -666 Point Dow Down Day

Unless you are one of the lucky few who is cruising the Caribbean, without power, or otherwise disconnected from the world today – you have no doubt heard of the financial fallout following S&P’s downgrade of US Debt and resulting market activity: Dow down -635 pts (-5.55%), Nasdaq down 175 points (-6.90%), S&P down 80 points (-6.66%), and Oil down -$6 (-7.18%)  while Gold rallied over $68 dollars to a new all time high. All of this follows losses last week, and we now have US markets down between -15% (Dow) and -24% (Russell 2000) from their 2011 highs.

Even as stocks open higher this morning, the lesson remains- the stock market can be truly brutal, and with uncertain political and economic conditions placing a stranglehold on the markets, there’s no way to tell whether or not this bounce will be a durable one.

We’ve been fielding calls from clients and others all day and wanted to share some of the conversations we have had in response to concerns.

1.  Are my funds at risk if the clearing firm’s bank goes bankrupt (ala Lehman)?  

With Bank of America down -20%, Citi down -16%, and JP Morgan down -9% today– this looks like more than just a theoretical exercise at this point.

Luckily, the segregated account structure of futures trading accounts protects customers from incurring losses should the brokerage firm, clearing firm, or the clearing firm’s bank go bankrupt. 

This segregated structure means that client funds on deposit are not subject to any offset, indebtedness, obligation, or liabilities of any entity besides the customers themselves. These regulations are in place so that the clearing firm cannot dip into the customer funds to offset losses elsewhere. The futures industry is a model of transparency, as well, with clearing firms required to submit a daily segregation computation to the National Futures Association.

This is one of the major differences from a Broker/Dealer firm (i.e Bear, Lehman, Merrill, etc). Those firms can borrow money (and say, invest it in subprime mortgages) based off the amount of customer assets they have, and they can lend money and securities based off the amount owned by their customers. 

With the banks usually many times the size of the individual clearing firms (usually tens to hundreds of times as large), clients have rarely, if ever (until now) been concerned about the possibility of the bank the clearing firm holds its money in going bankrupt. Usually a client is concerned about the brokerage firm they are using or the clearing firm that produces their daily statements, but thinks little of the bank the clearing firm uses (and rarely even knows what bank the clearing firm is using unless wiring funds to their account and listing the bank’s details). 

But with today’s activity, and renewed feeling that the financial system is not what it should be in the U.S., a new concern has emerged. What if the bank that holds the segregated funds goes under?

We put this question to our attorneys and a senior officer of one of our clearing firms, to double check our knowledge on it, and they confirmed that our understanding is correct.

And that understanding is that the customer segregated account structure carries all the way through to the bank level. In fact, the bank must issue a letter to the clearing firm stating they are aware of the “segregated account” status of the deposit, and will treat it accordingly. And only certain banks are allowed to carry a clearing firm’s segregated accounts. 

Finally, even if a clearing firm’s bank failed and the funds were not provided the segregated protection for whatever reason, the full capital of the clearing firm is between you and the failed bank. That is, you deposited your money with the clearing firm, and they have the obligation to return that money to you if you desire it. In a way, the bank failing is more the clearing firm’s problem rather than your own. 

There are regulations in place for how much capital an FCM must have on hand to meet such circumstances, and that capital amount must be reported and is transparent in much the same way the segregated customer funds numbers are.

It is important to note that forex accounts do not have the same segregated account structure, and are at risk of being used as firm capital. That is, forex accounts are at risk of being used in the very manner the government has protected futures customers from via the segregated account structure. We saw this in the Refco bankruptcy – with no futures clients we know of losing any money, yet many forex clients losing quite a bit.

In closing, we think it is more important to be worried about if you’ll ever be able to sell your house, your portfolio composition, putting your kids through college, or your future asset allocation percentages at this time rather than the safety and liquidity of your futures account. 

2.  Managed Futures are where you want to be in times like these.

Readers of this newsletter no doubt already know our stance on managed futures non-correlation to the stock market and ability to perform in times of a crisis. If not, see here. But the main point is, managed futures have tended to do well in times of stock market stress periods not because they are negatively correlated to stocks, but because they are long volatility investments which both win and lose when stocks go up and down – but which can win much more than when they lose because of their structure of risking a fixed amount and letting profits run [past performance is not necessarily indicative of future results].

2.5. Are managed futures currently exhibiting the crisis period performance they are expected to?

Yes, as we pointed out in our recent blog post, many ‘traditional’ managed futures programs which do some form of trend following switched positions over the past few weeks and are now in positions such as long Gold, long Swiss Franc, long Japanese Yen, long US bonds, and short foreign stock indices, creating a negative correlation to stock indices.

A few notable exceptions – option selling CTAs such as FCI, HB Capital, Clarity, and Cervino, and single sector/market contrarian traders like Paskewitz and Dighton Capital.

Which leads to our warning to make sure you are getting managed futures exposure out of your managed futures investment by investing in programs which have the long volatility profile mentioned above (i.e. not option sellers and counter trend programs).See here for more. 

3. How are option sellers doing

In a word: Poorly. We won’t know the exact damage done today until we see the client statements tomorrow, but our rough estimates in looking at positions coming into today are as follows: 


The problem here is that they are selling the very thing which has exploded in price: volatility. Meanwhile, the lesson to be learned on options sellers in the midst of this sell off is that there is a risk in these types of strategies - to the tune of one week/one day losses equal to a few months of gains. The silver lining… If they can survive the initial onslaught and their strike prices haven’t been pierced, the thing they are selling is now much more expensive, meaning more opportunity for profit (and more risk of loss).

4. Where are the opportunities in this sell off?

We always appreciate those who call in during large market moves not in a panic, but instead in a buying mood – asking who is getting hurt in the move and do we think that it represents a good entry level – and we received a few of those calls today.  We’ll never know why some investors see opportunity when others see fear, but respect those who do – as they usually outperform those who get in at the highs in our experience.

Besides the timing aspect of investing in drawdowns (getting in at the lows instead of the highs), these sort of contrarian plays can put an investor in a better frame of mind psychologically, as they may only need to risk 10% instead of 35%, or similar. The sell off over the past few weeks has presented several opportunities below. For more on investing in drawdowns, view our past newslettershere and here.

Our recommendations for ‘drawdown investments’:

·         Multi-Market: Covenant Capital Aggressive, Integrated Managed Futures Global Concentrated, James River Capital Corp Navigator, Robinson Langley Capital Management

·         Multi-Market Short Term: Accela Capital Global Short Term, Bouchard Capital, Dominion Capital Sapphire

·         Option Traders: Cervino Diversified 2X, FCI CPP, FCI OSS, HB Capital

·         Specialty: Dighton Capital CTA Ltd, Paskewitz Asset Management

Clarke Worldwide and P/E Investments are also worthy of consideration despite being two of the top performing CTAs in August as they remain in drawdown year-to-date.

5.  Trading Systems should do well (in our opinion) in the expanded ranges in the stock indices.

We’ve talked in this space before about how trading systems are built to risk a fixed amount (say $2,500) on each trade, but can earn profits equal to a day or two move in the markets they track (today’s move = 80pts * $250 = $20,000). When volatility is low, these systems can’t expect to make much more than they risk. At a 10 point range, the potential profit is $2,500 while the risk is $2,500. When volatility is high, the profit can be many times the risk – which is to the benefit of the system.


If we equate the average range of the market a system operates on as the potential profit they can achieve, the chart above shows that systems have the potential for about twice as much profit as they did just a few weeks ago.

Systems we recommend looking at to capitalize on the volatility spike include Compass, Strategic, and Bounce.

6.  Get a plan, and stick to it.

Times like these are not the times to panic. We’re reminded of 9/11/2001, when a client panicked following the tragedy that morning - calling in to exit all positions. Unfortunately, many of those positions were long bond positions, which appreciated greatly in the weeks following as stocks sold off sharply. Some clients today were  calling in selling S&P futures when already down -6% and buying Gold futures when already up… in a panic.

Even professional traders have a hard time making heads or tails of events like the past few days, so the odds of an individual being able to take in all of the necessary data and quickly make the correct call on whether to buy or sell something are astronomical, in our opinion.

Most of those reading this newsletter were likely drawn to managed futures and trading systems for the consistency of execution they provide. When invested in a manager, you don’t have to crunch the data and analyze the facts yourself. You don’t have to stare at the screen and wonder how much more pain you can take – the manager will have built in risk protocols in place to protect your assets.

This isn’t to say that professional managers won’t get caught off kilter from time to time. They can and will suffer drawdowns, and more often than not that drawdown will be more than what you expected. But one of the reasons you invest in a manager is to take away the second guessing and make your investing more disciplined.

Second guessing the manager during a crisis flies in the face of this disciplined approach, and will more often than not result in losses far exceeding those the manager may realize on their own over a 2 to 3 year period.

The best advice we can give in times like these is to stick to your plan. If the CTAs in your portfolio are doing well right now, thank your foresight to diversify into those programs as a crisis period hedge. If you are in a program which is suffering a drawdown right now, realize that drawdowns can and will happen with a managed futures investment. You should already have a line in the sand written down for when you will exit such a manager, and if you don’t - analyze whether that drawdown is outside of the normal parameters for the program and where that line in the sand will be if things digress further.

As one of our favorite bloggers, Barry Ritholtz is fond of saying: “Make note of where the exits are before the plane takes off, not while it is crashing…”

To read more Managed Futures research pieces, visit Attain’s Managed Futures Newsletter archive and our Managed Futures Blog.


Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex.  Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.

The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices:  such as survivorship and self reporting biases, and instant history.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

Copyright © 2011 Attain Capital Management, licensed Managed FuturesTrading System Commodity Brokers. All Rights Reserved. Reprinted with permission.