When Richard Scalone graduated from Columbia University with a degree in economics, he received two job offers: one was for an assistant purchasing agent position at Macy’s department store and the other was for an overnight trader at the Canadian Imperial Bank of Commerce (CIBC). The one-time All New York State wrestler chose the trading position and hasn’t looked back.
Five months later Scalone was hired by Chemical bank where he would soon become one of its top proprietary traders in its foreign exchange department.
With a growing family, Scalone was tired of his two-hour commute to Manhattan from Long Island and left Chemical shortly after it merged with Chase Manhattan Bank in 1997. Scalone wanted to be more involved in his four daughters’ lives but wasn’t interested in selling ties at Macy’s, so he created the Integra Master Fund and set up shop in Boca Raton, Fla.
Scalone now coaches his daughters’ soccer and basketball teams along with a youth wrestling team while managing the $150 million fund.
Despite earning more than 22% in two of its first three years, investors got nervous following a rough quarter in 2002. Scalone chose to reduce leverage in his discretionary program on the advice of an institutional investor who wanted to invest in a low volatility strategy.
“We went from a focus on capital appreciation to capital preservation,” Scalone says. Integra was targeting returns of 20%-30% at the time with drawdowns under 10% (targets it met), but Scalone acknowledges he was still trading as a prop trader not a manager. He cut leverage by 50% and eliminated the S&P 500, which he says tends to be less liquid in stressful market conditions.
The fund trades mainly G7 currencies in the interbank market with some fixed income and enters all positions through buying options. Three indicators signal a trade. The first step is fundamental, the second, technical, and the third Scalone refers to as “market position analysis.” Scalone describes his program as extremely conservative because he will not take a position unless everything lines up. “All three steps must be met or I won’t do a trade.”
Integra’s basic positions last one to three months but Scalone will manage positions on a daily basis. He buys mostly 25-delta options, close to the money but not in-the-money. “The idea is to buy options far enough out-of-the- money so that they are inexpensive but not so far out that they won’t profit from a move in your direction,” Scalone says. Integra typically will buy calls or puts three handles out-of-the-money applying 1% to 2% of assets to premium.
As opposed to other discretionary traders who base their trades on fundamentals and use technical parameters to determine timing, Scalone gives equal weight to both. The third step looks at how various firms analyze Commitment of Trader reports.
Technicians avoid fundamentals because they feel price reflects the fundamentals. Scalone uses market position analysis to determine to what extent both fundamental and technical factors are worked into to the market. “It is a form of checks and balances... is the market saturated?” Scalone asks.
Integra tends to underperform during trending markets because of its conservative approach. “When everyone else is adding to their positions I am reducing mine...trend followers are at their most vulnerable when markets are about to turn,” Scalone says. That approach worked in the choppy currency markets of 2004 as
the Integra fund
“The market will often overextend itself. If everyone is long the euro, it must go down, you [can] get caught in the splashback,” he says. That way he avoids being in a crowded party near the end of a trend. “I don’t like my toes stepped on and I don’t like having beer spilt on me.”
In January his method earned positive returns despite being wrong. With the euro approaching $1.35 he bought $1.38.50 calls. He hedged that position by selling euro futures at $1.35.50. Though the futures position was smaller than the option position, when the euro broke to $1.27, it more than made up for the premium that was at risk.
“The beauty is that I made money being wrong,” Scalone says. By sterilizing his position he was able to remain long for free. And when the market tanked he bought back the underlying futures position at a profit.
In the two years since reducing leverage, Integra has compiled a compound annual return of 13.91% with a monthly standard deviation of 0.85%, outperforming nearly all other managers on a risk adjusted return basis.