COMMODITY FUTURES
than double the average profit from
Figure 3: Prices of Corn & Natural Gas Futures
1985 to 2002 period.
Example From the Summer of 2004
We will now provide an example from
the Summer of 2004 to illustrate the
monitoring of portfolio event risks.
Event Risks
There are two key risks to a pro-
gramme that is long commodities
through outright futures positions, cal-
endar spreads, and/or through process-
ing-margin spreads. The first is obvious.
The investor is assuming directional risk
Source: Premia Capital Management LLC
in individual markets as well as on the
strategy level. The second risk is less However, positions can behave non-intuitively during events. During
obvious. This type of investment pro- the Gulf War an outright position in gasoline reduced the event risk
gram is very sensitive to a severe shock of the portfolio while a gasoline front-to-back spread actually
to business confidence. Examples increased event risk. Why? The Gulf War saw the entire price struc-
ture of gasoline go dramatically higher, but traditional
TABLE 2: PERFORMANCE OF SPRING GAS TRADE
market participants were not always able to keep ‘nor-
(Per Contract in USD) mal’ intra-market relationships in line during this time.
Profit/Loss (P/L) An examination of the portfolio’s worst-case scenarios
Through Trade Worst- Stop-
then assists in the design of macro hedges for the portfo-
Horizon Mark Out P/L
lio’s risks.
2003 -8,400 -11,176 -5,288 -5,288
2004 9,622 -2,675 NA 9,622
2005 1,147 -25 NA 1,147
Macro-Level Hedging
2006 14,120 -802 NA 14,120
As discussed above, after assembling all of our strategy
2007 13,663 -2,495 NA 13,663
buckets, we combine them into a portfolio and stress test
Average P/L from 2003 through 2007: 6,653
the portfolio through eventful times. We also examine
Source: Premia Capital Management LLC
the portfolio’s historical worst mark during normal times
as well as examine the recent volatility of the portfolio. If
include the 1990 Gulf War, the Long any of these measures exceed our portfolio's risk threshold, we can
Term Capital Management Crisis, and do one of two things. Reduce all of the positions to get the portfolio
the aftermath of 9/11 2001. In each of in line with our risk limits or attempt to curtail risk through macro-
these scenarios, a standard VaR analy- level hedges and keep the portfolio ‘as is’.
sis would underestimate risk. It is also
the case that during ‘eventful’ times,
TABLE 3: EXAMPLE OF A STRATEGY-LEVEL RISK REPORT
the portfolio can behave in non-intu-
Incremental Contribution to:
itive ways.
Portfolio Worst-Case Portfolio
The first column in Table 3 shows the
VaR* Event Risk*
effect on the portfolio’s VaR when
Strategy
adding the strategy to the portfolio
Gasoline Front-to-Back Spread 1.62% 0.64%
during ‘normal’ times. The second col-
Deferred Outright Gasoline 2.93% -0.72%
umn shows the change in ‘eventful’ risk
Deferred Outright Natural Gas 0.52% 0.16%
when the named strategy is added to
the portfolio.
Deferred Eurodollar Futures 0.77% -2.86%
Hog Spread 1.18% -0.29%
Worst-Case Scenarios
Deferred Gasoline Spread 1.33% 0.29%
This portfolio was especially sensitive
Cattle Spread 0.25% -0.32%
to a Gulf War (1990) event, and the
* A positive contribution means that the strategy adds to risk while a negative
‘eventful’ risk numbers are from run-
contribution means the strategy reduces risk.
ning the portfolio through that period.
Notes:
During ‘normal’ times one would
While under ‘normal’ times, the gasoline spread position is less risky than the out-
right, during particular ‘eventful’ times the spread adds to risk while the outright
expect a gasoline front-to-back calen-
reduces risk.
dar spread to be less risky than an out- While under ‘normal’ times, the Eurodollar futures position adds to risk, during par-
right position in gasoline. Indeed, this
ticular ‘eventful’ times this interest-rate position reduces risk.
was the case, as Table 3 shows.
Source: Till and Eagleeye (2006)
56 SEPTEMBER 2007 COMMODITIES NOW
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