Few commodity trading advisors (CTA) have an advanced degree in particle physics, years of experience as an actuary in reinsurance and can claim to have designed trading systems for Monroe Trout. But Aaron E. Schindler, founder and head trader at Schindler Trading, can. Schindler holds a bachelor’s in physics from the Massachusetts Institute of Technology and a master’s in physics from the University of California in Berkeley.
While there, he got acquainted with some people at a reinsurance company where his wife was an actuary. The firm was looking for someone with derivatives experience to help hedge everything from hurricane risk to interest rate risk. “I got to be Centre Reinsurance expert in hurricane and earthquake modeling,” he says, adding that writing insurance is very similar to option writing. “They are very similar in that you only get paid if you take on risk and you only want to take on the risks you are going to be commensurately paid for; and diversification is a big topic in both. You don’t want to write all of your Florida home-owners policies in Miami, just like you don’t want to make all of your futures trading bets in the energies.”
Schindler’s experience in modeling catastrophes and his years of “breathing statistics” has helped him produce a cumulative return of 281% for his short-term systematic program since its Sept. 1, 2001 launch, but those kinds of returns are only possible with high volatility, which he admits can be scary for some investors. Before April 2005, when he cut his leverage and volatility in half, his worst monthly drawdown, in July 2004, was 48.92%.
“At the depth of this drawdown I sent out an investor note mid month, which I don’t usually do, showing how — with the high volatility, with the high leverage I was using — this kind of drawdown is very possible and it doesn’t mean the strategy is broken.” His investors stayed with him.
He hastens to point out that the Nasdaq, still 55% below its March 2000 peak of 5132.52, was down 75% below its peak in October 2002, and yet people still buy tech stocks. “That kind of drawdown, after that kind of bubble, is to be expected.”
In the two years since, the fund is up 146%; and while his volatility is still twice that of a typical CTA, he now targets a standard deviation of 8% and has managed to stay below that target. Despite some ugly drawdowns Schindler has never had a down year. Since cutting leverage in half in April 2005, his program returned 6.33% for 2005 despite being 15% in the hole after the first quarter and is up 22.57% year-to-date through August. By cutting leverage, though he may never have another year like 2002 (96.96%), he should keep his drawdowns to a manageable level.
Schindler’s program currently trades 11 markets, including stock index futures, metals and energies. Most of his trades have a one- to three-day hold period and he adds a new market every six months. His program is completely systematic and automated. “My computer is back in my office right now, I hope it’s making money. It’s executing trades there.”
His programs is short-term and depends and making quick small profits. Schindler says each of the 11 markets, or ‘strategies,’ as he refers to them, all have well-defined rules that have been back tested. And whereas he used to do a lot of Monte Carlo simulations for reinsurance for hurricanes, he now brings that same methodology to futures trading.
“You’ve got a database of a 150 hurricanes that have formed in the Atlantic basin throughout the past 50 years; and you make some distribution of how many will form each year in the United States and what kind of damage. And [you] simulate distribution for expected losses for a given year in Florida and model where your policies are located and get a distribution for what your losses are going to be,” he says.
“It’s the same thing for futures trading. You buy an oil contract and do a simulation of your holding period, say three days. You can look at historical volatility. You get a distribution for volatility and get a distribution for how far the price could go in three days. And based on your assets under management, and how much risk you want to allocate to this trade, you get a distribution of your profit and loss. You hope for the profit, but be prepared for the loss.”
