Lesson 6 of 25 · 7 min
A commodity fund, 2006: one concentrated natural gas position
When your position is a large share of the open interest, your exit is itself the price move.
Amaranth Advisors was a multi-strategy fund whose capital was reported in mid-2006 at roughly nine billion dollars. By that summer the great majority of its risk sat in natural gas futures, and within that, in calendar spreads — long one delivery month against short another, principally the March against April 2007 pair, where storage economics make the gap unusually volatile.
The size relative to the market is the whole story. Reporting at the time put the fund's holdings in some individual contract months at a large fraction of total open interest. A position that large is not a participant in a price; it is a component of it. Track 7 lesson 8 gives the general measure: position size expressed in days of trading volume, not in dollars.
Through August and September 2006 the spread moved against the position. Losses triggered margin calls from the clearing arrangement, and meeting them required reducing the position, which required finding buyers for a spread whose only large holder was the seller. The realised exit price was therefore worse than the marked price by an amount that grew with each tranche sold.
Reported losses were roughly six billion dollars over a few weeks, most of it in September 2006. The fund stopped trading and the remaining book was transferred to two other firms at a discount. No new instrument was involved and no counterparty failed. A concentrated position met a deadline, and the exit cost was a function of the concentration.
Concentration is not measured against your capital. It is measured against the number of people who can take the other side this week.
Key terms
- Calendar spread
- A long position in one delivery month against a short position in another. It isolates the price gap between the two dates rather than the level of the commodity.
- Open interest
- The total number of contracts outstanding in a given contract month. Your share of it is a better measure of exit risk than your share of your own portfolio.
- Market impact
- The price move caused by your own trading. It is not a fee, it is not quoted anywhere, and it scales with your share of the market.
Worked example
Exit cost as a function of your own share
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A calendar spread on 80,000,000 units of gas entered at $2.15, supported by $120,000,000 of capital, held against a market where you are 42 percent of open interest.
- Spread falls to $0.94
- $1.21 of adverse move
- Mark-to-market loss
- $96,800,000
- That loss against capital
- 80.7%
- Further move caused by your own exit
- $0.18
- Exit cost on top of the mark
- $14,400,000
- Total loss realised
- $111,200,000
$2.15 − $0.94.
80,000,000 × $1.21.
$96,800,000 ÷ $120,000,000.
The consequence of being 42 percent of open interest.
80,000,000 × $0.18.
92.7 percent of capital.
The market took 80.7 percent of the capital. Getting out took another 12.0 points, and that part was self-inflicted by size alone.
Check yourself
A spread position on 30,000,000 units moves $0.46 against a fund with $25,000,000 of capital. What share of capital is lost before any exit cost?
Saved in this browser only. No account, nothing sent anywhere.
Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.