A. No, we are not always in the market. We trade 100% S&P Put Options. Often, after expiration, we are out of the market analyzing the best window of time and “strike price” to enter the marketplace. The time this takes, ranges from one day up to 2 weeks, depending on key factors which include the Volatility index and the length of the option cycle. Due to our conservative nature, we typically enter the market with 3-4 weeks until expiration. This limits market exposure in highly volatile markets always coupled with higher deltas or the rate of change that underlying options have with added time.
Q. What type of system do you use and to what extent? I.e. technical, fundamental, discretionary, trend-following, counter-trend, reaction or anticipatory, chart patterns, seasonal cycles, spreads, options, arbitrage and so forth?
A. We trade 100% S&P Put Options and very seldom will we sell calls. We trade on about 80% technical/historical analysis and 20% Fundamental/discretionary analysis. There are times we use credit spreads when writing the options however, the majority of the time, we write outright positions. Again, this is determined mainly on time and volatility.
Q. What is your estimate of the number of round-turns you make per year, per million dollars?
A. Approximately 1500 round turns per year, per million dollars
Q. What is the average length of winning vs. losing trades?
A. We write a new option position each month so the length of both losing and winning trades ranges from 3 to 4 weeks.
Q. Who designed the underlying trading systems you use?
A. I, Timothy F. Goodnight II, personally designed the entire underlying trading system through my own trading analysis and experience. There are no outside trading systems.
Q. Are you subject to any licensing agreements?
A. No
Q. Are there any limitations to your system?
A. We feel there are limitations in every program. We feel our main limitation will be the amount of capital under management. Because we sell deep out of the money options with a short amount of time left until expiration, the further away ‘from the money’ the less volume and liquidity there is, so I estimate that in order to get all my fills for my clients and keep quality control high, I will cap out my program at or around $50MM.
Q. Does your system have a long or short bias?
A. We take positions in the market on three to four week cycles so in that case, I would say short bias. Our strategy is not aimed at hitting home runs, rather we go for singles and doubles, in order to achieve the best results, I feel an investor needs to be positioned in the program for the long term and benefit from the consistency of maximizing the best risk-adjusted monthly returns.
Now if you mean a long or short market bias, we feel our program is unbiased to market movements. For the most part, we will achieve our monthly returns whether the markets rise or fall.
Q. Do you inform your clients of minor changes to your system, methodology or risk control?
A. We have been more conservative in the placement of options since the February market drop and we have relayed our position on the markets to all our clients and expressed our feeling for the need to move to a more conservative bias.
Q. Do you anticipate making any further changes to your systems?
A. We update the program with each month’s data point so the program is constantly adapting to market changes and we will continue to do this. This has helped to return us to equity highs in what we believe to be a reasonable amount of time.
Q. What are your contingency plans in the case of illness or death of key personnel?
A. In the event of my death, trading would be halted and positions would expire or be offset. In the event of my illness, we have staff here with GCM and with our respective clearing firms to manage the risk and exit positions if the S&P 500 index drops to a predetermined level during mid cycle.
Q. What circumstances would shut your system down and close all open positions?
A. If an event were to take place that caused the S&P 500 index to drop precipitously (i.e. more than 7-10% one or two days) this may cause the program to sustain a large drawdown, in which all open positions would be closed. In all likelihood, we would then roll out to another option strike price (again, deep out of the money ) to attempt to recoup some of the losses made in the first trade. However, in our strategy, we believe, great opportunities exist in this sort of high VIX and fearful market environment. Investors must be aware that the risk of unlimited loss exists in selling options.
Q. What is the method of re-entry into a market if you are stopped out?
A. As in February of 2007, we reanalyzed the technical and fundamental situation and reentered according to our updated numbers allowing us to make more than half of the drawdown back in 30 days.
Q. What type of research do you do on an ongoing basis?
A. We spend every business day reviewing and following the movement of the market as well as the correlation the movements have on the VIX and premium changes the underlying options experience.
Q. Do you enter a market on strength or weakness for trend-following trades?
A. There is no trend following in our program, we prefer to enter the market on weakness (or in a declining/ more volatile market) for every trade; however this isn’t always possible and historically hasn’t mattered too much.
Q. What markets are your principal focuses?
A. Solely options on the S&P 500 futures index.
Q. Do you intend on trading any cash, currency cross-rate or option markets?
A. No.
Q. What type of option strategies do you use?
A. Volatility selling and time decay. We feel that we are very disciplined, sticking to our general rules, then timing the entry point of selling deep out of the money Put Options on the S&P 500 with approximately 3-4 weeks until expiration. Distance, strike price, and timing are at the discretion of Tim Goodnight.
Q. Do you trade foreign markets?
A. No
Q. Do you ever trade delivery month contracts?
A. We always trade the front month, there are no delivery months for S&P 500 options since all index futures contracts are cash settled.
Q. Do you trade inter and/or intra market spreads?
A. Rarely. We use intra market credit spreads in times where the market is acting irrationally and has greater than average volatility
Q. What is your allocation to various market sectors?
A. 100% Put Options on the (front month) S&P 500 Index futures contract.
Q. How often do you change or review your asset allocation?
A. Never
Q. What is your method for determining initial and ongoing exposure?
A. We usually have an initial margin requirement of $2,500-$5,000 per position and write 1 position per $8,000-$10,000 of customer equity, therefore using a 50%-70% margin to equity ratio.
Q. Do you scale in or enter an entire position at once?
A. We enter the positions all at once
Q. Do you scale out or exit an entire position at once?
A. Every position or option cycle we have traded except one (Feb 07) expired worthless. The one time we had to roll our position, we rolled/exited all at once eliminating our exposure at that strike price.
Q. What are your risk management parameters?
A. We write options with a around a 1% chance of going in the money. However, as we know there are times when the market moves against you causing a drawdown that exceeds your limits. In this case it is our strategy to exit immediately, and reevaluate and position ourselves accordingly keeping the new market environment in mind and hopefully allowing us to recoup most if not all of the drawdown. Our set parameters begin this process between a 3-5% drawdown in equity.
Q. How do you manage volatility or changes in volatility?
A. Our program welcomes volatility. When there are sudden changes in volatility, we adjust our strike price from month to month to attempt to reduce risk and maximize returns
Q. Do you ever purposely stay out of a market?
A. When the market was making a large move to the downside in May of 2006, we decided not to take a position for a day or two in order to review the market and take full advantage of the added premium in the underlying options due to the increased volatility
Q. How do you manage drawdowns and subsequent recoveries?
A. Drawdown’s are a part of trading and our program has worked well in all types of markets. Therefore we feel it is important for us to continue to manage the money pursuant to the program details through drawdown’s and recoveries. We have seen people get away from their strategy during drawdown’s or try to make up too much too soon during recoveries. We feel with our program, being we update our positions and adapt to the market every month, we are in a position where we can manage drawdown’s well and have structured recoveries resulting in a smooth equity curve.
Q. How do you manage dramatically winning/losing positions?
A. We have strict parameters in getting out of option trades that get pressure from the market right after we sell them. Since we sell within 3 weeks until expiration, we look the time left, volatility, distance among other measures to use in making the decision to get out of the trade. In all but one case our options have expired worthless and we knew what our returns would be when selling those options from day one. Being that we are in the age of global markets, there are times the market can make dramatic moves overnight resulting in potential losing trades. It is our belief that exiting is the best way to manage these situations and letting the market try to take a “breather”. We have heard of other manager’s say they trust their research and standard patterns and most of the time this may work. All it takes is one time where the market doesn’t correct and you can be wiped out. I use this strategy for the sake of capital preservation. If you can manage the bad times, the good times will take care of itself.
Q. What is the maximum capital you can manage with your current system?
A. We feel $40-60 Million is our comfortable range. We’ve made this decision from observing of other programs and their returns as the assets under management grew. In the world of commodity futures and options trading, size is not always a good thing.
Q. How will equity growth affect your current trading program?
A. We don’t feel we will see much affect until the $40-60 million mark and at that point we will close the program to new money.
Q. What is your fee structure?
A. We charge a 1% annual management fee, 20% incentive fee on new profits only and we also allow an introducing broker to choose between a flat $45 round turn commission rate or a $23.00 round turn commission with an annual selling concession of 3.75%.
Q. What separates you from everyone else?
A. Very simple; Discipline. Finding a manager who sticks to his or her strategy is crucial. It is also difficult to find money managers who can put the risk before the reward and remain customer oriented through good and bad times. Our goal is not to have the highest returns, but rather to produce the most consistent, attractive returns with the least comparative risk and volatility. My goal is to have a quiet program that takes small steps forward practically every month as opposed to a program that earns 40% with large volatile swings that can eventually implode the program, turning all the gains into losses. Our goals are to provide the highest risk adjusted rate of return to our clients over a long period of time. Although there can be no assurances, we believe that our strategy can exceed the benchmark for alternative investments (i.e. Tremont hedge fund index) through prudent money management and have the potential to produce 15% - 20% average annual returns over any rolling 3 year period.
Investors should be aware that past performance is not indicative of future results. GCM’s investment strategy focuses on the writing (selling) of S&P options on futures contracts. Investors are advised that the risk of loss associated with the selling of options is unlimited. |
