Trader Brian loss from gas future
Introduction
The Amaranth Hedge fund, headquartered in Greenwich, Connecticut, was founded by Nicholas Maonis in 2000, and it built a solid reputation within the hedge fund community due to its energy transactions, before the infamous scandal happened. After helping the fund make significant profits in gas after the major disruption suffered as a result of hurricanes Katrina and Rita in 2005. Amaranth’s head gas trader Brian Hunter made another bet in the following year another extremely leveraged bet on natural gas price moving higher. However, with natural gas supplies increasing the threat of severe hurricanes diminishing, the price of natural gas continued dropping and Amaranth’s losses grew up to $6 billion. At the beginning of the year that it experienced its downfall it had $7.4 billion in assets and just before the month of its downfall it had assets worth $9.2 billion.
Story of the trader
Hunter first became outstanding as an energy trader at Deutsche Bank in 2001, and he was specialized on natural gas trades. He performed remarkable and personally earned $52 million and generated around $17 million profits for his company. At the end of2003, Hunter’s group earned about $76 million in profit. Unfortunately, within a week’s time, he had incurred losses of approximately $51.2 million. A series of similar negative events forced Hunter to leave his position at Deutsche Bank, and start his next career at Amaranth Advisors as head of the energy trading team. Hunter made $200 million for the hedge fund only within his first six months, which impressed his boss and made himself a lot of rewards and great compensation (Goodman, Leah, 2014).
His achievements impressed his bosses who in return as a gesture of good will build an office in Calgary, Alberta which allowed this Canadian trader to move back to his home town. In 2006 March, he was named among a list of top traders where he was number twenty-nine in Traders Monthly. He continued to profit Amaranth. It is estimated that he earned the company around $800 million and as a result of these huge profits he was rewarded with about $75 million. But then something went wrong in his predictions one time and he was responsible for leading to the closure of the company (Mccall, 2009). Hunter was 32 years old when he sunk Amaranth’s $9.6 billion hedge fund. Following the law suit that was made due to his attempt to try and manipulate the prices of natural gas he agreed to pay $750,000 to resolve the law suit against him. The details of the law suit were disclosed by New York Federal court.
Gambling on weather
Most of the investments that Amaranth had made were conservative and the energy department consistently earned annual returns of 30%. Hunter was able to come to more speculative conclusions using natural gas on the future contracts of the company. This worked in his favor when hurricanes namely; Rita and Katrina were responsible for disrupting the process of producing natural gas which in return increased the price of natural gas at this particular time Hunter’s speculation were correct and he earned the company $1 billion and a good reputation (Mccall, 2009). He made a risky bet and it paid off in 2005 but this was not always going to be the case since the same bets would be responsible for bringing down the company in the following year.
After weather was responsible for propelling the returns of the company it was only natural for Hunter to gamble on weather again the following year 2006. Meteorologists has already warned that severe hurricanes like the ones experienced in the previous years would not occur again, Hunter went further and placed a high bet on the prices of natural gas moving high like in the previous years. The inventories that are needed to ensure gas supply increased and the threat of hurricanes diminished. In September the same year the price of natural gas fell bellow its support level which was $5.50 and went ahead to drop by 20% by two weeks. This spontaneous drop in the prices of natural gas meant that Amaranth was losing. Its loss amounted to $6 billion within the span of a very short time (Mccall, 2009).
By the third week of the month of September in 2006, the United States was not experiencing any major hurricanes that would distort the supply of natural gas, therefore, its price continued to fall drastically. Amaranth has invested in the future of natural gas it is known that it used borrowed money to double down its initial investment. Their future contracts had higher equities as a result of the leverage that they had given to their traders. Hunters prediction on the weather had been made to win the company high returns in the year 2007, the period between March and April. When his strategy was at the verge of losing, he compounded the losses that were taking place in Amaranth by using the strategy of doubling down which included borrowing more fund and used them as leverage and eventually Amaranth ended up having borrowed $8 billion for every $ 1 billion that they owned (Mccall, 2009). The funds of the company declined and went below $3.5 billions and was later liquidated. Its loss led to the loss that was experienced by San Diego Employees Retirement Association which has invested $175 million with the company after its huge success in 2005.
By placing a large hedge fund Amaranth was trying to achieve larger gains by hedged positions. In an ideal situation Hedging is responsible for lowering the risk of the funds. And if the contracts they had invested in in the future were to move in one direction, then the funds would be responsible in profiting one contract as the over was used to hedge in the opposite direction. However, many hedge funds make huge bets on moves they are sure about unlike the huge bet that was made out of its former results. If trade of the future contracts would have gone as planned and speculated, Amaranth and its investors would have benefited greatly. This strategy of benefit on hedge funds does little to minimize the risk that would occur if the contract moves in the direction that was not speculated. And since all the contracts went in the opposite direction that was not speculated Amaranth bore a very high risk (Mccall, 2009).
Following the collapse of this huge company many reports concluded that the loss they had incurred had exceeded 65% of their initial investment. It transferred its assets to a third party that consisted of Citadel LLC and JPMorgan Chase on September 2006. Fortress investment was responsible for liquidating its assets and in the following year Amaranth and Hunter were charger with trying to manipulate the prices of natural gasses. Following the collapse of Amaranth so many law suits followed (Mccall, 2009). Its collapse marked the collapse of the largest Hedge fund in the history.
How trading went wrong.
The only thing that seems to have gone wrong was Hunter’s prediction on weather. And his speculation that the same hurricanes that occurred in 2005 were likely to occur in 2006. Also hedging a large amount of money on future contracts was a wrong decision since they failed to put in place possibilities that the future contracts might move against the direction they had predicted. Like all hedge funds those of Amaranth were kept secret although it is well known that Hunter had made a large investment on the speculation that the prices of natural gas would go high. Also, the fact that it placed its hedge fund and did not at all put any strategy in place to minimize the risk might be one of the reasons things went wrong (Mccall, 2009). Also, Amaranth and Hunter made the mistake of confusing paper trading gains with cash profits. Hunter also when he took his chip off the table and lost around $5 billion for a hedge that boasted of having a world class system for risk management. Amaranth also let a ruthless dealer take large risks without properly measuring the risk or without senior management involving the risk team. They also failed to dedicate resources and expertise to study the market but instead they made a decision following possibilities of certain events happening.
Aftermath
On the other hand, taking into account the aftermath of the whole situation, it implies that the majority of the initial energy investment that the company made was ultimately considered to be more conservative. As a result of that this mandated the energy desk to end up posting annual returns which was estimated to be 30% more than what was earned during the previous years. Consequently, it gave Hunters the potential or the opportunity of making speculative positions through utilizing some of the future contracts that were aimed at improving the economic wellbeing of the company (Timeline-Amaranth's Brian Hunter settles with U.S. CFTC, 2014). Although this ultimately worked in favor of the calamities that the company had experienced earlier, the continued production of natural gas extensively assisted in pushing its price throughout the whole year.
Proper economic investment is one of the factors that have been noted to have the potential of improving the performance of the business enterprise. Because of that, the speculations that Hunters had is the one that proved to be the precise means of correcting the existing flaws as well as increasing what the company could have earned during the epic season or reputation. Therefore, this implies that Amaranth, especially, Hunter were left with no choice but to extensively invest in natural gas futures as well as on the basis on the reports that were initially obtained from various potential natural gas investors. The reason for that is because the money that the company had borrowed was the one the management authority perceived to have the opportunity of doubling their initial investment (Mccall, 2009).
Nonetheless, research regarding the activities of this business indicates that the intention of Amaranth and Hunter was to achieve large gains taking into account the hedge funds with the hedged financial positions. Taking that into account, the hedging strategy of the company ought to take into consideration the risks to be encountered. The reason for that is because such invested funds consist of both bearish and bullish positions. As a result of that, it means that in case the future contracts that the company was to have been aimed at ensuring that it has ultimately moved it in similar direction. This is to imply that the hedging funds ought to have the ability of profiting the business with a single contract. Ideally, this is to suggest that some of the contracts that the management authority could have entered into might have been already sold or just used for the purpose of hedging against a particular movement that was directed in the same profit earning criterion (Timeline-Amaranth's Brian Hunter settles with U.S. CFTC, 2014). Despite that, the management authority of the company later ended up realizing that a large percentage of the hedge funds is the one that has the potential of making he bets in the existing market as well as moving in one particular direction concerning the company’s leveraged bets. Furthermore, this means that in case the traders performed as planned, the company ended up realizing that the funds invested by potential investors could have seen profound returns (Inshakov et al., 2019).
According to the modern economic world, contracts to be entered in the near future are the one that has the ability of increasing risks as compared to equities. What causes that is the leverage that the business organization ends up offering to future traders. For instance, when it comes to equity market, a trader is recommended to come up with more than 50% of the entire value of trade. Therefore, what the company realized, especially Hunter is that traders, in the future market has several opportunities of entering a market position that has only 10% of the finance up front. The reason for that is because a large percentage of the hedge funds that the majority of these companies that they obtain mainly comes from external borrowing through advancing credit from banks which in return make them to add more leverage. As a result of that, the effect of this is that it increases risks as well as the potential size of the profits that company will generate in the long run (Mccall, 2009).
Conversely, to counter the effect of this, Amaranth, especially Hunter also ended up implementing a strategy that was aimed at playing or enhancing the financial spread between the contracts that were entered. Because of that, Hunter was forced to bet the general spread between the hedging decisions that was to widen those contracts. Although such a strategy later narrowed down, Hunter had no option but to compound loses that was obtained through utilizing doubling down strategy stated above. In the process of embarking on external borrowing so as to initiate new financial positions, the end result of this is that the hedge funds ended up becoming more and more leveraged (Hunt & Evans, 2009).
At the end of the day, the truth is that potential investors concerning the Amaranth Fund were ultimately left stranded scratching their heads as well as wondering the kind of investment that could have been made on their funds. Thus, the lack of transparency was also one of the issues that they considered to have made their funds not to be wisely invested. As time went by, it was realized that such investors had no idea about the hedging funds were ultimately doing with the invested funds. In other words, the hedge funds ultimately come with free rein with respect to the invested capital. The reason for that is because it was later realized that the majority of the hedging funds is what end up making their money to come up with performance fees which can in return be generated through leveraging its gains (Goodman, 2014). From economic perspective, the large the gains, the better the financial position the company will be in in respect to the hedging funds. For instance, in case the funds were to remain at 70% or fall below that, it implies that the general performance fee could have been decline to zero. What the management authority realized from that is that the structuring of their fee is the one that has the ability of improving the focusing of hedge fund traders as well as implementing some of the exceedingly risky strategies (Fuerderer et al., 1999).
How to prevent from the situation (my strategy)
From the information that was initially collected, it was found out that Amaranth used to make sells that was ultimately more that its energy portfolio. As a result of the liquidity and margin calls, it is evident that the company did not have the potential of seeking alternative selling strategies in their energy sector. As a result of that Amaranth later ended up conforming that Brian Hunter had secretly left the company although that was an extremely minute comfort for potential investors who could have invested a lot of funds to the company (Goodman, 2014). As a result of that, for the company to prevent such a situation, it is important for the company to ensure that such investors have not been left with the option of liquidating all that was left out of their initial investment after the transaction was carried out aimed at selling its assets.
Despite of the past investment, it is also important for the stakeholders to ensure that they have illustrated all the risks that were involved when it comes to making such a large investment in the hedge funds. In the process of resolving seeking external borrowing, it is important for the management authority to come up with other new financial strategies that will ensure equable utilization of the existing resources (Mccall, 2009). The end result of this is that the hedge funds will be easily leveraged.
Conclusion
With respect to the above scenario, the truth is that the regardless of the epic downfall that was experienced, the hedging funds of the business needed to be wisely invested. Equally, the failure of Hunters to foresee the forthcoming risks of his rated is what ended up rendering him blameless. On the other hand, although this had absolutely worked in accordance with the strategies implemented, the objective behind that entailed favoring some of the tragedies that the business had initially experienced. Conversely, the continued generation of natural gas is what they company and its stakeholders perceived to have the ability of increasing its future prices. The wellbeing of any business organization relies on the profits to be generated which in return increase its economies of scale. Therefore, proper economic investment is one of the factors that the company could have also realized to have the potential of improving the performance of the business enterprise. Equally, the speculations that Hunters had is the one that proved to be the precise means of correcting the existing flaws as well as increasing what the company could have earned during the epic season or reputation.
References
Fuerderer, R., Herrmann, A., & Wuebker, G. (1999). Optimal Bundling: Marketing Strategies for Improving Economic Performance. Berlin, Heidelberg: Springer Berlin Heidelberg.
Goodman, L. M. (2014). THE 'ROGUE TRADER' WHO GOT AWAY WITH IT. Retrieved from https://www.newsweek.com/rogue-trader-who-got-away-it-271105
Hunt, L. C., & Evans, J. (2009). International handbook on the economics of energy. Cheltenham, UK: Edward Elgar.
In Inshakov, O. V., In Inshakova, A. O., & In Popkova, E. G. (2019). Energy sector: A systemic analysis of economy, foreign trade and legal regulations. Cham, Switzerland : Springer Press
Timeline-Amaranth's Brian Hunter settles with U.S. CFTC. (2014). Retrieved from https://www.reuters.com/article/amaranth-settlement/timeline-amaranths-brian-Hunter-settles-with-u-s-cftc-idUSL2N0P413B20140915
