Feb

28

The Rule of Two: Brian Hunter Update

Teresa Lo @ 9:30 AM | | Start a Discussion 

The March 3, 2008 issue of Canadian Business has the latest on the ex-Amaranth trader, but what intrigues me is how ex-Enron John Arnold’s Centaurus Energy was playing the other side.

“Always two there are; no more, no less: a master and an apprentice,” said Yoda of the Sith Lords while Darth Bane concluded, “Two there should be; no more, no less. One to embody power, the other to crave it.” It’s the Star Wars Rule of Two.

Market speculation: The trials of Brian Hunter
NG futures are later-date contractual obligations to deliver or receive 10,000 million British thermal units of natural gas at the Henry Hub, a pipeline junction in Louisiana. The game is played by a mishmash of speculators and commercial interests who buy and sell thousands of contracts (and options to buy or sell contracts) on a daily basis. Most never hit the Hub because obligations to deliver and receive often cancel each other out. Nevertheless, until settlement day on the New York Mercantile Exchange (NYMEX), all futures fluctuate in value due to numerous volatile factors, ranging from market fundamentals to the mood of Mother Nature.

Such price fluctuations can translate into a seriously bad trading day. In September 2006, for example, a string of Hunter’s bad days eventually cost Amaranth US$6.6 billion, which is more than the GDP of Chad. But believe it or not, Wall Street was still trying to toss big money Hunter’s way while CNBC was reporting on the fund’s fruitless efforts to survive.

That won’t surprise you after you know the whole story, which has never been reported before. For now, let’s just note that Amaranth — despite what you might have read in the business pages or on financial blogs — did not crash because a math geek placed ridiculous bets on something as unpredictable as hurricanes in the Gulf of Mexico.

Hunter’s strategy back in 2006 was based on monthly price spreads, not on an expected storm-induced jump in prices. (Such a jump could have actually hurt Amaranth’s positions at the time.) Not that Hunter is afraid of risk. He played the March–April “widow-maker” spread, where the unpredictable effect of warming weather on natural gas supply scares some traders off the market. But his overall position was hedged, highly calculated and not 100% weather-dependent. In fact, the bets Hunter made could be considered conservative when compared to what some debt traders were doing with sub-prime assets at the time.

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