Informative Facts On Zenith Resources, CTA
Writing Options on the S&P 500 Ed Padon is in charge of trading for a Texas-based CTA named Zenith Resources. He has devoted the better part of his professional career, some 14 years, to the art of option writing and trading the futures markets. It has paid off handsomely! (See disclosure document.) Instead of profiting through the purchase of individual shares of stock (like Microsoft, Pfizer and GE) which are in the benchmark S&P 500 Index; Padon sells options on the Index itself. In fact, he specializes in selling (writing) put options. Why puts? He feels that ones chances of picking the one big winner out of all the component companies that make up the S&P 500 Index is akin to looking for the proverbial needle in the haystack. Another good analogy Padon uses to explain the advantages of writing put options versus buying individual stocks, is that it equates to an archer having to hit the bull’s-eye each time. While writing put options on the S&P 500 Index, allows the archer to hit any place on the target and not just the bull’s-eye. Furthermore, when buying stocks a person has slightly less than a 50-50 chance of the trade being profitable, the stock must move higher or pay good dividends. When employing Padon’s strategy of selling put options on the S&P 500 Index, the market can move up or down, stay flat and/or move sideways and a profit potential still exists at option expiration. Be advised that this strategy involves a substantial risk of loss. An investor could lose more than the initial investment. According to Padon, it's more prudent and beneficial to play the long side of the market, and to do so by writing put options. He has two main reasons for this: He believes that a market top is harder to pinpoint than support, due to irrational exuberance that shows up in the marketplace at times. He has seen too many traders’ short change themselves, by thinking the market can’t go any higher and they sell calls based on that thought. More importantly, for the same statistical risk, writing put options enables the writer to collect substantially greater premiums than writing calls. Padon did not arrive at his conclusions by chance. He formulated a trading system and back tested it over the period of 1988-1999. He discovered that the strike price of the puts, selected by his system, had never gone ‘in the money’ prior to option expiration. This is the goal of every option writer! Padon was now ready to trade real time, and commenced trading in December 1999 by primarily writing put options. From January 2000 through December 2002–one of the worst periods in market history—the S&P lost approximately 40% and his program earned 91%! Clearly the Texan’s program has affirmed the attractive results generated over the back testing period. Past performance is not necessarily indicative of future results. The risk of substantial loss exists in writing options. An investor could lose more than the initial investment Vision and the ‘V’ Program Vision L.P. has arranged for Padon to trade on behalf of Vision IB’s Clients. Clients will be traded under Zenith Resources ‘V’ Program, which implements the same trades as the “General Program” (see page 11 of Zenith Resources disclosure document). The difference in programs lies not in the trades executed, but solely with the fee structure. Government regulations require the establishment of a separate performance table for the V-Program, because Zenith Resources “General Program” assesses clients a graduated incentive fee up to 50% of new net profits. The V-Program will offer clients of Vision an opportunity to choose one of two equitable fee
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structures: a 2% annual CTA management fee combined with a 20% incentive fee, or 0% percent CTA management fee in conjunction with a slightly higher 25% incentive fee. The commission structure differs slightly between the two programs. However, the differing performance between the two programs should not be material. An Ideal Means of Portfolio Diversification What investment strategy do you have that can potentially capitalize on a bull market and also help protect your portfolio and capitalize on a lackluster or even bear market? Investors can take comfort in knowing that by employing Padon’s investment approach, they have the opportunity to potentially capitalize not only on bull markets, but also sideways, lackluser and bear markets! The beauty of Padon’s option writing investment strategy lies in its versatility. Again, the General Program of which the V-Program will replicate, produced very attractive returns from January 2000 through December 2002, by essentially playing the long side of the market via writing puts. Over the same time period, the S&P 500 lost almost 40%. [Note that his strategy, though able to perform in any market, does not guarantee profits in all markets.] Money Management is Crucial Ed Padon will primarily trade on the long side of the market by writing out of the money put options on the S&P 500 Index. He looks at trading from a risk perspective. He believes, if one can manage the risk, attractive returns will come with a good trading system. He writes the options shortly after the expiration of the previous months options, generally 100+ basis points or “handles” away from the market, with four to five weeks left until expiration. This is the equivalent of approximately 800 Dow points. If the cash market moves within 40 to 50 handles of his strike price, he will buy an option, thereby creating a “credit spread,” and effectively limiting the risk and margin requirements for the trade. Of course, if the S&P 500 cash index closes above the strike price of the puts at expiration and the position was not hedged up, then the trade will be profitable. If the CTA is wrong and the market moves against the position, the trade could result in a loss up to the entire amount of the spread differential. A credit spread is created by selling an option, and purchasing another less expensive option. When writing a credit spread, the writer is "credited" the difference between the premium collected from writing the option, less the cost of the option purchased. The option credit spread risk is limited to the difference between the strike prices of the option written and purchased, plus commissions and fees. Any loss would be further reduced by the amount of the credit received. While the option credit spread clearly offers the advantage of defined risk, the writer must sacrifice some of his potential profit in exchange for acquiring a limit to the potential loss. S&P Put Credit Spreads If a put spread is written on the S&P 500, and the spread is not closed out prior to expiration, the strategy will be profitable if the S&P 500 futures price is above the strike price of the put written when the spread expires. If the futures price of the index is below the strike price of the put when the put that was written expires, the strategy may produce a loss. The loss will be limited to the amount of the difference between the strike prices of the two options in the spread. For example, if a put with a strike price of 900 is written, and a put with a price of 875 is purchased, the maximum loss on the spread is 25 points, minus the original credit on the spread. If this spread
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were originally put on for a credit of 5 points, the maximum possible loss is 25 x $250 = $6,250 minus the original $1,250 credit, or $5,000 plus commissions and fees. [Please note: The example given above is hypothetical and for illustration purposes only. Option credit spreads can be liquidated before expiration, with a profit or loss, based on market movement. It is Mr. Padon’s opinion that in most instances of losses, the credit spreads will be closed out at a loss substantially less than the maximum spread loss.]. The System will initially write put options on the S&P 500. This will result in a trade that could present unlimited risk to the investor. At such time that a “credit spread” is established, an investor could lose all or a portion of the amount invested. Slow and Steady Wins the Race Unlike many traders who loose on the majority of their trades and depend on a few good trades to make up for their losses and thereby generating positive returns, Zenith Resources takes the opposite trading approach. They use a methodical approach to trading. The performance record shown in their General Program, is the result of many smaller winning trades that have produced 91% winning months. (Padon, for good reason, often speaks of his trading methodology being more akin to a singles and doubles hitter and not a “slugger”. Anyone who understands the game of baseball, or trading, for that mater, understands that singles add up!) From a psychological point of view, we believe it is much more comforting to be with a trader who has a good potential for consistent returns, as opposed to being with one whose program is volatile and experiencing wide swings in equity. Bear in mind that past performance is not necessarily indicative of future results. The risk of substantial loss exists in writing options. An investor could lose more than the initial investment IRA Approved IRA, pension and other retirement funds are approved for investment with Zenith Resources. Conclusion Consistency is one variable that is very rare in speculative investments, but one Zenith Resources has demonstrated. We believe the market has now seen its worst, but will also not see its best for the foreseeable future. This environment could potentially be excellent for Padon’s trading system. Ed Padon is general manager and trader for Zenith Resources, a Texas-based Commodity Trading Advisor (CTA). Padon graduated in 1982 from Southwestern Adventist University with a BBA degree in accounting and, in the same year, was honored as a member of “Outstanding Young Men of America.” Ed was also active in his community, and elected councilman for the city of Keene, Texas. Ed started trading commodities in 1990. For approximately 9 years he did extensive research in the development of proprietary formulas for writing options and trading the futures markets. He initiated his managed futures program in the S&P 500 Index options.
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