From the February 01, 2011 issue of Futures Magazine • Subscribe!

Lewis launching right on time

When Paul Lewis took a class in futures and options at the University of Michigan he thought it was cool and knew what he wanted to do. By the time he graduated, he had a plan that eventually would lead him to create commodity pool Cypress Energy LP. "I wanted to go to Chicago," Lewis said. "I had an uncle who lived in Chicago and figured I could bunk for free and just go down to the exchange and find a job doing anything, and that is what I did."

Lewis particularly was interested in options, so he went to the Chicago Board Options Exchange (CBOE) and got a job as a price reporter. This was in 1990, and he developed some friendships that led to an opportunity at O’Connor and Associates.

He took a clerking job in the Deutsche mark options pit at the Chicago Mercantile Exchange. At the time, O’Connor was in the process of merging with Swiss Bank Corporation and forming a commodity trading unit. In 1992, Lewis moved to New York and became a member of the New York Mercantile Exchange.

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"It was a good opportunity for me. In FX options I was a small piece of a big pie and I thought this was a good opportunity to be a larger piece of a growing pie," Lewis says.

While a valuable experience, the trading unit floundered and Lewis was back in Chicago contemplating whether to go back to school or back to FX when he started getting inquiries from head hunters in Texas as the oil and gas business began to open up.

"Instead of the good old boy business, you were starting to find guys from the Midwest and Northeast come down to Texas to run trading shops for companies like Williams, El Paso and Dynegy," Lewis says. He was hired as head options trader for Enserch Energy Services that would eventually become TXU, trading its natural gas portfolio.

"My job was twofold — leverage info we were getting from our client base and help our marketers to come up with hedging products to offer to our end-user clients," Lewis says.

Lewis remained with TXU until 1999, then joined Netherlands-based Vitol S.A. He helped establish their natural gas business and three years later was called up to the big leagues. The big leagues being Houston-based hedge fund Centaurus Energy.

Although he had a strong understanding of gas markets, he went to school working alongside Centaurus’ John Arnold. "My philosophy was refined; it took on a much more fundamental view."

He would take a longer view of the market. "In the long run the markets trade toward their fundamental value; in the short term they constantly are straying away from that fair value."

Lewis was the head options trader at Centaurus during a difficult time to trade options. His results were mixed and he longed to trade natural gas outrights and spreads. So, in 2006 he went on his own to build a track record to launch his own fundamental discretionary fund.

He produced strong returns, more than 100%, each of his first two years trading proprietary money. Then, in 2008 he launched Cypress, which trades the entire energy complex, but focuses on natural gas, trading outrights and spreads and options to enhance those returns.

Shortly after launching, Lewis brought in Chris Papousek, a colleague from O’Connor, to help with risk management and operations. "He puts on options trades and I help quantify the risk," Papousek says.

The key is identifying mispricing and taking advantage of it. "I wouldn’t call it reversion to the mean, I would call it reversion to fair value," Lewis says. "The idea is to come up with those mispricings, maybe it is something you missed from the day before, maybe it is because the market [recently] did something different, but you are constantly looking for mispricings whether it be on an outright price level or a relational level."

Cypress has strict risk management, but no rigid stops. "It is not a good reason to get out of a trade just because you have some losses; you get out of a trade because it is not a good trade. Sometimes the best thing to do is double down, sometimes the best thing you can do is get out even if it hasn’t lost money.

"We have a strict risk policy as far as [position size], as far as value-at-risk on a daily basis, on a weekly basis, on a monthly basis and on an annual basis. We have drawdown limits. We only are allowed to take a position that is a certain percentage of our net asset value," Lewis says.

And so far, it has produced solid risk-adjusted returns. Cypress has an annualized return of 24.33% since launching in July 2008 with a Sharpe Ratio of 1.13, and was up 8.72% in 2010.

While his road may seem long, Lewis believes his CPO, which manages $16 million, is in the right place at the right time.

"There have been a lot of new fundamental factors in the natural gas market, from increased supply from shale gas, to efforts to utilize that supply to make natural gas the main transportation energy source. All these relatively new factors are good for a fundamental gas trader," Lewis says.

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