One CTA Hu allocated capital to was emerging options writer Diamond Capital Management. After several promising years, Diamond began to struggle and basically was knocked out after the volatility spike of 2008. Hu did some accounting work for Diamond when it was on the ropes and worked out an arrangement where he would be the lead trader for a new strategy.
Hu thought if he could combine his option strategy with his trend-following and trend reversal programs, it would make a solid diversified program. “If I can put them together, if I can figure out how to [adjust] my trend-following system to fit stock [indexes] then I would have a much better system,” he says.
Hu was never a marketer so he began trading the approach — first with the trend and option writing program — through Diamond. Kelly Farrell, principal with Diamond, would work on raising money and Hu would trade.
“The trend-following strategy tries to capture major movement of the market and is biased to the long side,” Hu says.The systematic long-term strategy trades E-mini S&P futures.
The option writing program looks to sell deep out-of-the-money S&P 500 puts on a monthly cycle. Though focusing on puts, there are times he will write calls. “If I am long the futures, then I may write so-called covered calls. There also are times that far away calls have [strong] premium,” Hu says.
There also is a value element. “If the volatility is too low, then we will skip writing,” he says.
The program, which began trading in mid-2009, did well and by 2011 Hu added a revamped reversal strategy, the last leg in the program though it is based on a strategy he developed in 1987.
The reversal strategy averages only three to four trades a year, but Hu estimates it will account for more than a third of the program’s returns. “The winning probability of that signal is [more than] 80%,” Hu says.
The last signal was a short on Oct. 5, the most recent high for the Dow Jones Index. He also had a sell signal on May 1 that captured a significant top in the S&P.
He uses intermarket analysis to spot reversals in this rules-based strategy. “I look at precious metals, industrial metals, interest rates, [major global] stock indexes and every stock in the Dow Jones,” Hu says. He adds up all those factors and makes a call.
The program is up 22.79% in 2012 through October, and has produced a compound annual return of 15.78% since launching.
When Hu and Farrell made their arrangement, they agreed it would run three years, at which time Hu would retire or start his own fund depending on assets raised. He now manages $5 million for his own qualified eligible participant-only CTA, Cauldron, and $2 million at Diamond. He will continue to trade for both as long as it is manageable, but judging by recent performance, he should expect to become busy soon.