Commodity prices tend to crash upwards while equities crash downwards. But the November 2018 spike in natural gas volatility was, in some respects, analogous to the February 2018 spike in equity volatility. Both events inflicted double digit losses on a number of funds, and spelt the demise of others (such as the XIV ETF, and optionsellers.com) that had substantial short volatility positioning. Yet certain managers also profited from the market action, including Ron Ozer’s Statar Capital GP LLC (Statar), which has maintained a long volatility bias for most of its track record.
Since inception in September 2018, Statar has delivered a Sharpe ratio of over 2.0 and importantly has kept its volatility just shy of the 16% annualised target, even as natural gas’s implied and realised volatility surged into triple digits. In fact Ozer has somewhat surpassed his annualised return target of 20%, which is based on mid-teens volatility and a Sharpe ratio of 1.5. The return profile has also shown minimal correlation to commodities (as measured by the Bloomberg Commodities Index) and equities (S&P 500).
The market is very keyed on daily data, which has thrown up some bearish surprises in June. We adjust our forecasts on a daily basis in response to data.
Ron Ozer, Statar Capital GP LLC
Ozer has spent almost his whole career trading natural gas. He was most recently co-head of US natural gas trading at Citadel. Before that he spent six years at DE Shaw & Co, where he was given a great deal of autonomy to trade natural gas. Internships at Lehman Brothers and Morgan Stanley piqued Ozer’s interests in trading, so much so that he graduated a year early from MIT with a BS in Math and a Minor in Economics.
While Statar – named after MIT’s Stata building with an ‘R’ added for Ozer’s first name – pays homage to his alma mater, he “has no regrets about attending the ‘graduate school’ of trading in 2008-2009”. Joining DE Shaw in August 2008 proved to be a baptism of fire that let him, “learn from the subprime crisis, and watch spreads and volatility being traded by DE Shaw’s active, fundamental gas trading unit, which takes its own decisions on risk”. Ozer started running risk for DE Shaw in 2010 and contemplated going solo in 2015 but was lured to Citadel’s natural gas business. A year after leaving Citadel, Ozer launched Statar with three additional team members – a senior analyst, a senior developer – and a seasoned COO, Terrence Brennan, who has helmed operations at two other asset managers for over twenty years.
Ozer, 31, has founded his own firm at a remarkably young age because he believes there is extraordinary potential for his distinctive natural gas trading strategy. He asserts that, “the opportunity set now is the best ever in my career, due to a confluence of factors”. Companies that need to hedge natural gas prices, typically to stay inside their debt covenants, or consumers that prefer predictable costs, are in effect alpha donors. And even the profit-seeking natural gas trading community has seen an exodus of capital as banks, hampered by regulations and solvency rules, have shut proprietary trading desks, while at least 100 commodity hedge funds have also ceased trading or downsized over the past couple of years. On top of that, a substantial amount of investment capital trading natural gas is now passive and/or systematic with fewer traditional, discretionary fundamental traders competing with Ozer. Flows are very important and Ozer is often populating liquidity vacuums that arise from imbalances caused by lopsided flows.
Whereas some systematic strategies will structure certain types of trades rather mechanically, Ozer’s has a “quantamental” approach – blending fundamental views with quantitative analysis and heeding technical factors. It’s an approach that’s completely opportunistic in terms of how he rotates the book around his repertoire of mainly relative value trades. For instance, some systematic (and discretionary) strategies seek to pick up a risk premium – that is often characterised as “positive carry” – from the roll yield that comes from the backwardation of natural gas calendar spreads. “The notion of roll yield for backwardation is the reason why the spike in prices and volatility last winter happened,” says Ozer. It contributed to crowded short positioning in such horizontal spreads around October 2018 (and particularly in the March/April contract where the spread is often most pronounced) but Ozer’s fundamental data analysis led to a different perspective. He can trade calendar spreads in either direction, but late last year he was of the opinion that, “storage at record lows created a risk of gaps in price action – and ultimately a risk of there being insufficient gas to meet demand. Storage for the US market is not supposed to end October at an obscene level of 3,208 billion cubic feet. Two standard deviation cold weather would have wiped out inventories. This scenario is in the distribution of outcomes, and the market should not have let itself get into that situation.” The “roll yield” from natural gas is stupendously high because the fat tail scenario can be morbidly obese. Ozer was able to position Statar appropriately to take advantage of the market conditions.
Since inception, Statar has delivered a Sharpe ratio of over 2.0 and importantly has kept its volatility just shy of the 16% annualised target, even as natural gas’s implied and realised volatility surged into triple digits.
Ozer could have 0% or 100% in any of his trade types, which include directional, volatility, and relative value trades – and various combinations thereof. It is relative value trades that distinguish him most from other natural gas traders who are more focused on either directional or volatility trading. He points out that, “We can put on spreads versus spreads; spreads versus directional trades; spreads versus volatility, or spreads versus calls and puts, and get paid for providing liquidity in distorted parts of the curve”.
The combination of Ozer’s broad expertise in the energy space, and more specific perspective on the natural gas markets, give him the opportunity to see trades where others do not. The structure of Statar allows Ozer to invest with a broad mandate, to the benefit of the firm’s investors.
One generalisation that can be made is that Ozer has been long on volatility to varying degrees for most of the fund’s life. He structures the positioning carefully, sometimes trading one risk premium against another to reduce the net cost of the exposure. Ozer has also ephemerally been short of volatility, in very small size. The past nine months has seen a rollercoaster ride for natural gas implied volatility, which sextupled from c20 to c120 before retracing back to the 30s. “Even at the highs, the implied volatility was not in fact underpriced since realized weekly went as high as 190 and realised monthly hit 130,” he says. (A strategy of gamma trading options bought on IV of 120 could have been profitable given that RV hit higher levels.) “These levels of volatility were the highest I have seen over my ten-year career, and were probably exacerbated by the failure of optionsellers.com,” he adds.
Some fundamental traders develop high convictions and then “bet the ranch” on their base case scenario. This can at times even appear to be reflected in consensus market coordinates. Ozer declares that, “the market pricing of the natural gas curve in late 2018 extrapolated one month of weather patterns into the future, which ascribed an unrealistically high probability to a narrow range of possible outcomes”. He takes a probabilistic approach, structuring a portfolio of trades that is designed to have an attractive risk/reward profile under various different scenarios, including warm, cold and normal weather. He does not claim to have prophesied the extremes of late 2018, but he did construct a portfolio profile that could profit from a reasonable distribution of outcomes. Ozer is not a meteorologist and does not claim to have an edge in forecasting the weather, either, but he is adept at mapping out how weather patterns will impact on the natural gas market, relative to what is already factored into pricing.
The notion of roll yield for backwardation is the reason why the spike in prices and volatility last winter happened.
Ron Ozer, Statar Capital GP LLC
Weather extremes can cause surprises in both directions: very cold weather can increase heating-related demand for natural gas, while very hot weather can add to air-conditioning related demand for electricity generated from natural gas. Weather-related volatility could become even more important in future: some meteorologists have opined that climate change increases the incidence of extreme weather events, such as hurricanes and typhoons, which can have a dramatic impact on natural gas prices (as in 2005 after Hurricane Katrina). The phenomenon of negative prices for associated gas in parts of the US is not directly relevant to Ozer since he only trades the national benchmark price, but negative gas prices are indirectly relevant in signaling that natural gas does not conform to a normal distribution bell curve. Extreme outcomes should be discounted, but may not be where Black Scholes option pricing assumes lognormal distributions. Therefore, Statar will often own the tails of the distribution and may profit from black swan events. As well as controlling volatility, Ozer looks at risk from various angles, including “Greek” sensitivities for option trading, and crash perspectives.
Ozer does not trade physical natural gas: “we do not move any molecules,” he says. He currently only trades US natural gas futures and options based on the key Henry Hub US benchmark price. He mainly trades on CME Group (which reported record trading volumes in natural gas contracts in November 2018), with some ICE and NFX exposure. All of this is exchange-cleared with no OTC counterparty exposure. Ozer likes to stay in hyper liquid markets partly because he has been an extremely active trader. He also wants to be able to swiftly switch positioning if this is warranted by price action.
He can overhaul his book too if new data changes his fundamental thesis. He finds that, “the quality of data at national US level is good. Data sources include Department of Energy reports; other data from vendors; daily power burn metrics; imports from Canada, and LNG exports to Mexico and Europe”. If some equity investors take a view on multi-year trends, such as shifts from coal to natural gas, or from fossil fuels to solar and renewables, Ozer is more focused on daily observations. “The market is very keyed on daily data,” he says, “which has thrown up some bearish surprises in June. We adjust our forecasts on a daily basis in response to data.”
Statar does not trade regional spreads within the US, nor spreads between the US and other geographies, but Ozer watches this data as it reveals clues for assembling the US natural gas jigsaw. For instance, the transatlantic spread in gas prices helps to determine demand for US LNG exports. As of June 2019, Ozer observes that, “the arbitrage between US and European natural gas prices has largely collapsed as warm weather has created a glut. But as volumes are contractually fixed, it can take some time for relative pricing changes to feed through into the fundamentals”.
As firm assets grow, Ozer plans to add top talent to the team – including a European energy analyst to add some European gas contracts to the investment universe. Culture fit and expertise in the industry are top criteria for talent. He could also contemplate trading weather futures if they became liquid enough, as a hedge for certain natural gas positions. For now, the US natural gas markets are providing a wealth of trading opportunities. With the strategy now fully built out Ozer is optimistic about capitalising on this compelling opportunity set.
At the same time, Ozer’s ambitions are practically calibrated to the size of the natural gas market; his initial capacity target over time is USD 500 million; assets were USD 320 million as of August 1st, as the firm ramps up its strategies in its first year. The natural gas trading community is a fairly small world where Ozer respects and admires many of the key players. The stand-out trader in the field was Centaurus Capital founder John Arnold, who featured in The Hedge Fund Journal’s “Tomorrow’s Titans” report, and has now retired from natural gas trading. “There is no question that John is a legend, the indisputable natural gas God. I would be happy if I could do 5% of what he did,” Ozer declares.