CTAs or Commodity Trading Advisors Funds

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In this section of the course, we are going to focus on CTAs and systematic funds. What are they? Why are they important? Why do we follow them, and how can you track them? Using Menthor Q Systematic Models let's start.

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Systematic funds drive what are known as systematic delta and volatility flows. Delta flows refer to the market movements driven by algorithmic trading strategies. These funds typically employ algorithmic trading models to follow trends across various markets, including commodities, currencies and equities. By using technical indicators and historical data, the funds systematically adjust their market exposure, or delta to capitalize on perceived trends, making their approach a form of systematic delta strategy. These strategies used by institutional investors and hedge funds, often involve rebalancing portfolios to maintain a target level of market exposure or to hedge against potential market movements.

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Systematic volatility flows instead refer to the trading activities that are automatically executed by algorithmic trading systems based on changes in market volatility. These flows are typically driven by signals that adjust their exposure in response to volatility changes, aiming to capitalize on volatility patterns or to hedge against potential volatility spikes. Such strategies may involve trading in derivatives such as options and futures, where volatility is a key factor in pricing. These systematic approaches to trading volatility can significantly influence market dynamics, particularly during periods of market stress or high volatility events. In the last decade, these flows have become impactful on the market.

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Their AUM is now well over a trillion dollars. That means that ignoring those flows will put us at a disadvantage. What we do every day in our trading rooms is understanding how positioning and flows are interacting before placing bets. We also want to look for notable changes that drive predictable flows as these big funds reposition or roll their positions. Ultimately, as investors, we want to be able to track these flows, understand and quantify exposure are these funds long or short?

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And project price triggers that will then drive flows and have a market impact. While we have already built some of these models within our premium membership, some of them are still work in progress. We will add to this course as we build them. Next we are going to dig deeper and look at CTA's funds. Understand what they are and then look at how you can track them.

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VRQ models, CTAs funds or commodity Trading Advisor funds are specialized investment vehicles that employ futures contracts, options on futures and retail off exchange forex contracts to invest in commodities and other financial assets. These strategies can range from systematic trading, which relies on computer algorithms and models, to discretionary trading where decisions are made based on macroeconomic data market indicators and the advisor's experience and judgment. Yet these funds are more and more quant funds. What do they use? CTAs that are systematically managed use mainly trend following strategies based on momentum signals to take positions.

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While every fund can have a variation, the funds as trend followers will mainly use moving averages and crossover strategies to create buy, flat or sell signals. It is important to note that CTA funds use normalized momentum indicators to signal trades across different timelines, adjusting positions based on realized market volatility. More established trends lead to longer asset exposures, whereas higher volatility prompts reduced allocations and vice versa. While this is an estimate, assets under management for these funds are now over $400 billion, making them a substantial player in the market when it comes to tracking liquidity and market flows. In this chart from Barclay Hedge you can see just how fast they have grown over the past few years.

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Because of CTA's fund's high correlation to moving averages, we like to track their flows in conjunction with our moving average models. More specifically, one can use the 20 or 50 period moving average as a proxy price trigger. You can access this chart and all our momentum models via our query bot within our premium membership. When the 20 period simple moving average breaks above this level, we can expect a buy signal for CTAs. When it breaks below that level, a sell signal.

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Here you can see the correlation between CTAs and trend following strategies. While the letter C stands for commodity, these funds are really active across most asset classes. They trade forex, equities, fixed income and commodities. Here you can find all the asset classes we cover vi our bot. We have the chart version for the main assets as well as table format for all others.

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While in the chart format you can find spot and positioning, in the table format you will also be able to see positioning on the day before, the month before and percentile. We have a dedicated guide that explains our CTA's model on our website. Because these strategies are momentum strategies and follow an established trend, investors see them as a tail risk strategy. One of the reasons for this is the fact that in a declining equity market, these funds will follow the trend to the downside and hence diversifying a long equity portfolio. Here you can find the correlation of Barclays CTA index to other asset classes.

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Instead. Here we can see how CTAs have performed during drawdowns of the S&P 500 index. If you are looking for a proxy index for these funds, we find that Barclays and Soc Gen are probably the best known ones Accessing it is not easy for retail investors, but our model tracks these funds closely, specifically the SOC Gen 1. When we built our models, we ensured that they had close correlation to it. Next, let's try to understand the time frame these funds are using.

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Because these funds can differ on holding period, CTA categorize their programs into short term, intermediate term and long term holding periods. Fund utilizing a short term holding period strategy will hold trades for a period of seconds to three months before offsetting. On the other hand, CTA using an intermediate term or long term strategy will hold trades for a period of three months to a year or for longer than one year, respectively. The specific holding period or time frame that a CTA strategy employs plays a direct role in their overall returns. What are the specific impacts that CTAs have on the Market?

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CTA funds can have several impacts on the financial markets. CTAs are active participants in various financial and commodity markets. They contribute to market liquidity by actively trading and providing bid and ask quotes. Their presence can help reduce bid ask spreads and make it easier for other market participants to buy or sell assets. Depending on their trading strategies, CTA can influence price movements in the markets they operate in.

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For instance, trend following CTA may amplify price trends by following the direction of the market, while contrarian CTA may influence reversals by betting against prevailing trends. Some CTA strategies thrive in volatile market conditions. When markets experience significant volatility, CTA funds may increase their trading activity, potentially contributing to an increase of volatility. CTA are often skilled in risk management. When market conditions become extreme or overly speculative, CTA may reduce their exposure to manage risk.

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This can help stabilize markets during turbulent times. CTA funds often invest across various asset classes, including commodities, currencies, fixed income, and equities. This can attract capital to less traditional markets and help diversify investment portfolios. The trading activities of CTAs can affect the correlation between different asset classes. For example, their trading can lead to increased correlation between various commodity markets, impacting how they move in relation to each other.

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Lastly, they can have an effect on systemic risk. If a significant number of CTAs employ similar strategies or have a high level of exposure to specific markets, it can create systemic risks. A sudden rush to exit similar positions by multiple CTAs can lead to market disruptions. CTA funds are not inherently long gamma in their trading strategies. They typically employ trend following models that do not directly involve options trading strategies like those that would generate gamma exposure.

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Long or short, their positions are based on the direction of market trends rather than the convexity of options pricing factors that gamma represents. However, the effects of their trading can resemble those of gamma movements in certain market conditions due to their strategies systematic buying or selling which may amplify or dampen market movements. This is a slide from our delta hedging lesson to show you what long and short gamma means. What does this mean for the market? If we take our gamma models, we can say that CTAs have the same effect on the market as a market maker would have when the market is in negative gamma.

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Let's understand why Positive gamma is typically associated with long options positions, e.g. long calls or long puts. The same can be said for multi leg strategies. Long straddles or strangles and long options spreads are positive gamma. Positive gamma indicates that the delta of an option will become more positive as the price of the underlying asset moves.

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For calls, it means that delta will move closer to 1 WA for puts to minus 1. This means that if the underlying asset's price increases, a positive gamma position will gain delta and if the price decreases, it will lose delta. When your strategy is long gamma, you benefit from spot price moments. Gamma scalping is an example of a strategy that benefits from a positive Gamma condition. Positive gamma positions are often associated with a directional outlook on the market.

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Traders who anticipate that the underlying asset will move in a specific direction can use positive gamma to their advantage by seeking strategies that align with their expectations. Negative gamma is associated with short options positions, for example Short calls and short puts. Credit spreads. Iron Condors, calendar spreads are negative gamma strategies. Negative gamma implies that the delta of an option will become more negative as the price of the underlying asset moves.

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If spot price increases, our delta will decrease and vice versa. If we are short gamma, we want to make sure the market remains within ranges. Large price moves can lead to losses. Changes in implied volatility can affect the risk associated with negative gamma positions. Rising volatility can lead to higher risk and potential losses which may require adjustments or portfolio rebalancing.

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Negative gamma positions can lead to wider bid ask spreads. Market makers and traders may widen their spreads to account for the additional risk they are taking on, which can affect trading costs for market participants. So when the market is in negative gamma, we know that delta hedging activity of the market maker accentuates market moves. That is because they have to adjust their deltas in the same direction of the price. For example, if the market is dropping, marker makers will short to stay delta hedged.

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The same is true if the market is going up. They will have to buy futures to stay delta hedged. This, in a way is the same concept applicable to CTAs. What we do know is that CTA will go long the market as it starts trending higher and short the market as it trends lower. This means if they can further accentuate a market movement the moment certain price levels are triggered.

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How do we read our CTA models? The red dot denotes CTA's current positioning. In terms of positioning when the chart is above zero, that is showing us that the model is long. So CTA will be long assets below zero. They will be short when they are long.

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They will be buying futures and injecting liquidity into the market when they are below zero. That means they are shorting futures and removing liquidity from the market. Now consider the instances delineated by the blue arrows which encompass three distinct scenarios. In the first scenario, CTA are diminishing short positions. CTA maintain short positions denoted by values below zero but are actively reducing their exposure.

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This shift suggests a revaluation of their market positioning. In the second scenario, we are transitioning from short to max long positions. This represents a transformation in CTA positions transitioning from short positions to maximum long positions. This notable shift signifies a substantial change in market sentiment. Lastly, CTA is reducing long positions.

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In the third scenario, CTAs persist in long positions and indicated by values above zero while concurrently diminishing their exposure. This dynamic implies a recalibration of their risk profile. Why should a retail investor consider looking at commodity trading advisor funds? CTA funds provide an opportunity to diversify an investment portfolio beyond traditional stocks and bonds. Because they often have low correlation with these assets, they can serve as a hedge against market downturns, potentially reducing overall portfolio risk.

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Investing in CTA funds gives retail investors access to professional management. CTA use their expertise to analyze and trade in various markets, including commodities, currencies and indices, which can be complex and time consuming for individual investors to navigate on their own. CTA funds offer exposure to global markets, allowing investors to benefit from trends and opportunities worldwide which might not be available through traditional investment channels. While they come with higher risk, CTA funds also offer the potential for high returns, partly due to their ability to use leverage to amplify gains. CTA can offer retail investors additional insights on liquidity.

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By injecting and removing liquidity, CTAs can have an impact on price, action and momentum of an asset. In the next lessons, we will look at our volatility models.