Amaranth, 2006

A spread trade too large to leave

Amaranth Advisors, a multi-strategy hedge fund, ran enormous positions in natural gas calendar spreads — long one delivery month against short another. The trade was not directional in the obvious sense and the margin on it was small. What it was, was most of the open interest. When the spread moved against the fund it could not exit without trading against itself, and roughly $6.6bn went in a matter of weeks.

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What the lesson covers

1. What happened
2. The position
3. Why it broke
4. What it cost
5. What it teaches

Key terms

• Calendar spread — Long one delivery month and short another in the same commodity, trading the gap rather than the level.
• Open interest — The total number of contracts outstanding, and so the measure a position’s size should be read against.
• Spread margin — The reduced margin charged on offsetting legs, on the assumption that they move together.
• Widow-maker — The March–April natural gas spread, across the end of the withdrawal season, and its reputation for violence.
• Position limits — Caps on how much of a contract one participant may hold, applied on a regulated exchange.
• Liquidation discount — The gap between a portfolio’s marked value and what a buyer will pay to take it on whole.

Every key term, A to Z

In practice

Exchanges and clearing houses now scrutinise concentration in spread positions rather than only net risk, and the reporting gap between regulated exchanges and other venues has largely closed. The trade itself is unremarkable and still runs on every energy desk — at sizes the market can absorb.

Read next

• Commodity Swap — Fixed price for floating market price
• Crack Spread Swap — Hedge the margin between crude and its products
• Swing Option — The right to choose how much you take

In the app, Amaranth, 2006 carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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