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July 06, 2007

CTA Confidential: Suninghill Managed Futures
by MA-Research.com

Originally published by Managed Account Research, Inc. on June 29, 2007

CTA Confidential^SM
"An ongoing series of qualitative investigations
into managed futures trading programs"

CASE NO. 0378822
Suninghill Managed Futures, LLC
Gregory Alan Tucker, Principal
Global Currency Program

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTING IN FUTURES AND OPTIONS INVOLVES RISK AND MAY NOT BE SUITABLE FOR ALL INVESTORS. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. THEREFORE, INVESTORS SHOULD CAREFULLY CONSIDER THESE RISKS AND DETERMINE WHETHER THEY ARE SUITABLE FOR INVESTING IN LIGHT OF THEIR FINANCIAL CONDITION AND INVESTMENT OBJECTIVES.

Gregory Alan Tucker Jr. is principal and trader for Suninghill Managed Futures, LLC, a commodity trading advisor registered since March 2006. Mr. Tucker has approximately nine years of trading experience in equities, futures and options. He began his career in 1998 at Unus LLC as a financial derivatives trader. Managed Account Research had the opportunity to interview Mr. Tucker from his office in Charlotte, North Carolina and discuss Suninghill's impressive performance to date, his background and his approach to trading. What follows is an exposé based on that interview.

A maverick is defined as "a lone dissenter, as an intellectual, an artist, or a politician, who takes an independent stand apart from his or her associates." Talking to Gregory Alan Tucker Jr., one gets the feeling you're speaking to someone who fits that description -- which in the business of derivatives trading fits into a long tradition that includes the likes of Jim Rogers who also comes from Alabama.

Tucker was a chemistry major and on track to go to medical school, but altered course due to chance events that evolved from $19,000 in US Savings EE Bonds his grandmother purchased for college. Rather than using the money for tuition, Tucker invested the proceeds in mutual funds. "Buy what you like, what you know" was the advice given him at the time. That recommendation turned out to be prescient.

An avid runner and weight-lifter in college, Tucker was a regular at a local gym and found himself talking to one of the establishment's old-guards who happened to be a broker. It was his sophomore year attending the University of Alabama at Birmingham and at the time he was taking the Series 7 which first introduced him to option trading. That old-guard's counsel regarding options, however, was to avoid them -- "options are highly risky; nobody makes money trading them."

Following his innate contrarian sense that one makes money in markets by ignoring popular assumptions, Tucker figured that if nobody in his clique understood options, it was likely this area was where profitable opportunities existed. The irony was that only a few months before he liquidated his technology mutual funds because he was "losing money in them."

In the past few years there has been an upsurge in the number of option trading programs being offered in managed futures. Investigation shows that the vast majority of these programs are based on the S&P Index with only a handful of CTAs offering programs that trade options in the other commodity markets. Suninghill's Global Currency Program is one such exception.

While Suninghill's disclosure document states that the Global Currency Program can trade stock indices and domestic energy contracts, the main focus of the program is true to its label with Tucker trading seventy percent currencies (Euro, British Pound, Swiss Franc, Canadian Dollar and Japanese Yen) and the balance focused on interest rates (T-Bond, T-Note and Euronote).

That said Tucker wants to remain flexible with his trading. The program has occasionally traded energy contracts in the past although he is not focusing on any energy trading currently. To date the program has also not traded equity indices, but he wants to leave the door open for their inclusion. On the other hand, Tucker is actively working to include foreign interest rate markets to further diversify the portfolio.

When one asks Tucker how he came into trading the Global Currency Program portfolio, the assumption is that it grew directly out of his activities as a derivatives trader at Unus LLC. While this is primarily true, it turns out that Unus focused mainly on individual stock options trading and generally used the equity futures index as a hedging tool. At one point though, Unus traded thousands of metals contracts.

The story behind Unus is an interesting one. It came about in 1998 as a closely-held family office trading operation which grew from the principal's interest in a friend's trading strategy selling at-the-money covered call leaps against out-of-favor stocks.

The principal put together a small team of students from the University. Tucker was initially brought on as an intern but quickly became an equal, with each trader bringing different ideas to the table against which the more exotic strategies had to be passed by the principal, who acted like a risk manager. The main strategy, however, was selling naked puts on a basket of 120 stocks including volatile technology stocks. In a bull market this is an excellent strategy as at worst naked puts act like a GTC buy entry stop -- meanwhile the strategy earns consistent returns through premium collection.

It was around this time that Tucker came across "The Handbook of Managed Futures" edited by Carl Peters and Ben Warwick and was inspired to set up Macro Economic Futures Trading, a commodity pool operator. The game plan was for Unus to evolve into the hedge fund business, but unfortunately 9/11 changed that. It wasn't so much the damage to the overall profitability -- Unus was double its original investment size -- rather, the principal decided the trading model wasn't worth pursuing further and dissolved the shop. After Unus closed its doors Tucker first tried establishing a financial planning practice, but his background, skills and interest was still oriented toward trading. Hence, he became registered as a commodity trading advisor.

Besides the fact the Global Currency Program is differentiated from other option writing programs by making currencies its primary focus, the program also sets itself apart by trading the underlying futures from time-to-time, as will be explained below.

Generally, Tucker likes to establish naked calls or puts on currencies three weeks out from expiration, with the out-of-the-money strike 2-3% from the underlying, and with $150 premium receivable per position per model account size ($10,000), or 1.5% potential gain per currency position. If he cannot capture the desired premium potential within these parameters, Tucker will move out the expiration timeframe 4-5 weeks. A similar approach is taken with interest rates, however, with these instruments the premium capture objective per position is anywhere from 50bps to 1.2% of equity.

In any case, a major consideration and discretionary aspect of his trading approach is to initiate positions on a countertrend basis, usually triggered by a 1% move against the prevailing trend. This is why fundamentals play a role in Tucker's trading and "helps build confidence when positions are going against you."

Tucker's conviction comes from the econometric database he's built around various major U.S. economic indicators. He's now expanding that database to include economic numbers from other countries in an effort to be able to model out interest rate and currency price parity under a variety of scenarios.

The key part of any program is risk management. It is here that fundamentals also play a role in managing risk exposure. For example, recently Tucker has been avoiding exposure to the Japanese Yen largely because of the volatility surrounding dynamics around the Yen carry trade.

Typically Tucker will maintain between one and four open positions at a time and try to keep them uncorrelated (Tucker runs correlations on a weekly and monthly basis). For example, he may establish a "synthetic cross" strangle by legging into a short put position on the Euro and a short call position on the British Pound. This diversification provides a second level of risk management, although it should be noted that when writing options, the more positions one has on the books the more it exposes one to a greater probability of an outlier event.

Tucker's most important risk management tactic, however, comes from his willingness to cover naked options, either when 75% of potential gain is realized even though the option hasn't yet expired, or to stop himself out of a position when the option has expanded to three times the initial premium value. A lot of option traders play roulette with probabilities resulting in the potential for risk of ruin, so this willingness to deploy a money management stop is another differentiation aspect of his options program.

It should be noted that there may be occasions such as when a naked option is going to expire within a week, that Tucker is willing to let the option go into-the-money, be exercised and converted into a futures position. At this juncture, Tucker will sell 1% to 1.5% in-the-money options to reduce the delta and establish a covered long (long futures, short calls) or covered short (short futures, short puts) position. If the market continues to work against his position, he will reset the in-the-money write or he may decide to hedge the position with a long option position opposite his short option position. All things considered Tucker has a great deal of flexibility trading options and in managing portfolio exposure.

In June 2007 the Global Currency Program suffered a 6-7% intra-month drawdown, but as of this writing it has come back approximately 25% from the trough. Prior to that, the program's biggest monthly drawdown was 3.89% which occurred in April 2006. January 2007 was another drawdown month of approximately 4% on existing accounts; however this is not reflected due to the time-weighting of new accounts added to the composite during that period and which where not exposed to certain pre-existing positions.

In light that Tucker has been averaging approximately 2.5% return per month for the Global Currency Program since inception through May 2007, the drawdown experienced to date has been well managed relative to the overall upside performance. Question is whether the leverage deployed in the program can avoid it from being "run down by a train" assuming a substantial increase in assets.

Given that the model account size is $10,000 and the composite margin-to-equity ratio averages 40-50% when positions are initiated and have historically reached as high as 80%, the question of gearing and capacity comes to mind. What is commendable is Tucker's respect for capacity; he thinks the program's capacity is between $15 and $20 million assets under management.

With respect to gearing, the granularity of such a small model account size means that capital utilization will generally be optimal. This is opposite of a CTA whose program conforms to a $50,000+ model account size for example. In other words, with the Global Currency Program a 10% gain on a $100k account would result in an increase of one contract (a 10% loss results in a decrease in one contract). At the same time, a $1 million account will find that every 1% change in equity results in a change in the number of contracts initiated in the account. This is a highly geared program!

But being highly geared has its drawbacks, especially with respect to liquidity. The majority of Suninghill's track record to date through December 2006 represents one account with $40,000 under management. As of January 2007 he's had a big pop in assets to over $1 million, and already he is beginning to deal with issues of partial and split fills.

If one extrapolates one currency contract per $10,000 to $20 million under management, then 2,000 out-of-the-money options at least 2% from the underlying will need to be executed at that asset size. A quick look at the July Euro option quote board on May 28th (expiration is six weeks away on July 6th) shows that with the underlying at 1.3475, there is only 360 open interest on 135 calls and 205 open interest on 135 puts. Upfront at-the-money June Euros with a 134 strike expiring in less than two weeks still only show open interest of 1,550 calls and 3,390 puts. Note these are open interest numbers for the most liquid currency contract (Euro) on at-the-money strikes, not out-of the money strikes.

It is likely that as Suninghill's size increase and liquidity becomes more of a concern that Tucker will need to de-leverage the Global Currency Program sometime in the future. For investors looking for 30%+ return potential this may eventually be a detractor, but we think the added benefit is greater downside risk management, and with the resulting reduced margins the ability to re-leverage an investment through notional funding is also possible.

Tucker is an unassuming, down-to-earth guy, a refreshing quality when compared to certain traders whose egos can get in the way of prudent risk-taking decisions. In fact, Tucker is very much a family-man -- his wife is an occupational therapist and they have a three month old girl. When not trading Tucker still enjoys running and weight lifting but more than likely you will catch him doing yard work, which as he says is "one of home ownership's necessary evils."

As stated in the beginning of this article, Tucker is not alone in his Alabaman roots. Jim Rogers co-founder of the Quantum Fund grew up in Demopolis and got started in business at the age of five selling peanuts. When he got his first job at Dominick & Dominick he "didn't know anything" about Wall Street, and "didn't even know that there was a difference between stocks and bonds," but Roger's "instantly fell in love" with that kind of work.

Tucker has a passion for trading too, and although Suninghill may only have $1 million assets under management, if he sustains the pace of his performance he will likely attract additional assets quickly.

Michael "Mack" Frankfurter
Chief Investment Strategist
Managed Account Research, Inc.

This article was written by Michael "Mack" Frankfurter, Chief Investment Strategist and an Associated Person of Managed Account Research, Inc. The analysis and opinions expressed in this commentary have been reviewed and is approved by a principal of Managed Account Research, Inc. as of the date of this issue. Every effort has been made to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. There is no guarantee that the forecasts made, if any, will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. This material does not constitute a solicitation to invest in any program offered by Managed Account Research, Inc. including any CTA trading program described in the above article which may only be made upon receipt of its disclosure document. Past performance is not necessarily indicative of future results. Investment involves risk. Investing in foreign markets involves currency and political risks. The risk of loss in trading commodities can be substantial.

For more information about managed futures, visit www.ma-research.com. You may also call (800) 308-1495 to speak to an Associated Person, or contact us via email at info@ma-research.com. A disclosure document for the above described trading program will be provided upon request at no additional cost. The mark: "CTA Confidential" is a servicemark of Managed Account Research, Inc.

The regulations of the Commodity Futures Trading Commission ("CFTC") require that prospective customers of a commodity trading advisor ("CTA") receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the clients commodity interest trading and that certain risk factors be highlighted. In some cases, managed commodity accounts are subject to substantial charges for management and advisory fees. It may be necessary for those accounts that are subject to these charges to make substantial trading profits to avoid depletion or exhaustion of their assets. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA. You may sustain a total loss of the initial margin funds and additional funds that you deposit with your brokers to establish or maintain a position in the commodity futures market. This and other risk statements contained herein cannot disclose all of the risks and other significant aspects of the commodity markets. Therefore, you should proceed directly to the disclosure document and study it carefully to determine whether such trading is appropriate for you in light of your financial condition. The CFTC has not passed upon the merits of participating in any of these trading programs nor on the adequacy or accuracy of any of these disclosure documents. Other disclosure statements are required to be provided you before a commodity account may be opened for you.

About the author: Michael "Mack" Frankfurter is the Chief Investment Strategist and an Associated Person of Managed Account Research, Inc., an independent Introducing Broker focused on advising its clients in managed futures investments. Mr. Frankfurter is also a co-founder and Managing Director of Operations for Cervino Capital Management LLC, a commodity trading advisor and registered investment adviser based in Los Angeles, California. Occasionally, he pens articles as a freelance financial writer.

Copyright © 2007-2009 Managed Account Research, Inc.; Michael "Mack" Frankfurter, Author.
All Rights Reserved.

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