Meet The Man Behind The Market's Relentless Ramp

Tyler Durden's picture

In an ironic twist of fate, it appears the catalyst for many of the biggest and most incomprehensible market ramps of the last few years is a fund called "Catalyst." With around $4 billion under management (before the latest collapse), the levered options fund is run by Edward Walczak who "uses options to create a better risk/return profile."

The Catalyst Hedged Futures Strategy Fund is an open-end fund incorporated in the USA. The objective is capital appreciation and capital preservation in all market conditions. The Fund invests primarily in long and short call and put options on S&P 500 Index futures contracts and in cash and cash equivalents, including high-quality short-term (3 months or less) fixed-income securities. 

A 'great/lucky' year in 2008 and solid returns since...

 

Until recently...

  • 1 Week -14.07%
  • 1 Month -12.61%
  • 3 Months -16.96%
  • YTD -13.56%
  • 1 Year -10.11%
  • 3 Year -1.08%

Things have not gone well since the election...

As we noted previously, the melt-up in the S&P is the result of "a purported / murky melt-down over the past week in a large trade by a multi-billion Dollar (open-ended) futures fund which sells vol on S&P.  Without going into specifics, there is market speculation that the entity is effectively short upwards of ~$17B of SPX (deltas to buy) through selling February expiry upside 1x5 (or 1x4) call spreads."

And here is the man that runs the show...

As FuturesMag.com detailed previously, Edward Walczak began his trading career after 25 years in business operations and supply chain management. It was Walczak’s experience running Chicago-based candy manufacturer Brach’s commodity hedging operation in the late 1990s that got him deeply involved in the markets.

At one point, Walczak’s boss asked him about position limits and he had no idea what he was talking about, Walczak says. “You only get embarrassed once and I spent a week with my trader [learning] the business and became intrigued by it.” Walczak is a math guy with degrees in Physics and Economics from Middlebury College and an MBA from Harvard, so naturally he was drawn to options. By 2005 he was making more money trading than in his day job, so he began trading proprietary money full-time and set up a commodity pool for friends and family. In 2006 his proprietary trading returned 52.68% and in 2007 he added customer accounts to the Madison, Wis. based Harbor Financial LLC.

 

Fortunate breaks come in all forms. For Walczak his biggest break may have been a painful February 2007  drawdown in his mainly option writing S&P 500 program. The drawdown was not fatal, 17.93% for the month, and the program was positive for the year, but it made Walczak rethink his overall approach. “Back in ’07, VIX was trading around 10 and all of a sudden the S&Ps dropped 50 handles in a day,” Walczak says. “A 50-point drop at the time was a big deal but historically was not that bizarre. It could have been a lot worse and I could have been wiped out, so I had to do something different.” He spent the next year researching. “How do I cover these other risks that are out there and how [do I] use options to have a better risk/return profile?” he asked himself.

 

He began a study of volatility and decided to move away from pure premium collection. “If you are strictly a premium collector, you have a couple of issues. If you collect $2, then $2 is the best you can make if everything goes right. Second, if that is the only way you can make money, then you often are tempted into doing a collection trade when the edge is not with you,” Walczak says.

 

What he discovered was a volatility trading strategy that could exploit rising volatility. “A simple example is you sell a front-month option and buy a back-month option. If you do that at a credit, you have the opportunity for the front-month option to decay in value or go away entirely and the back-month option still has value,” he says. “The secret sauce for us is in the placement. If you are correct with where you place these things, then you get the best of both worlds. You don’t just have residual value in that long option, the long option actually could explode in value while the short option goes away.”

 

The February 2007 wakeup call came enough in advance of 2008 for Walczak to complete his adjustments and earn 50% in 2008, a year that completely wiped out a number of option writers. “We found that rather than trying to trend-follow price to the downside, it is better with options to trend-follow volatility to the upside,” Walczak says. “Usually those are two conditions that go hand in hand.”

 

While the volatility trading strategy helped diversify the program and turn 2008 from a potential disaster to a home run, Walczak still was having problems in sharply uptrending markets. “Those really caused us a lot of problems with the techniques we were using, so I spent a lot of time [on that] and in 2010, we [began] to do some trend-following price wise.”

They still were using only options and found they could exploit trends more safely this way. The strategy uses a wide variety of ratio spreads, butterflies and offset butterflies. “It is basically 1 x 2s, 1 x 3s, 1 x 2 x 1s, where you are buying one, selling two, buying one,” he says. “That allows us to put trades on for little or no cost, so if the market tanks we are not long the market. We don’t lose money, the trade just goes away.” Walczak says, “It is not that we changed so much as we evolved: Premium collection, to premium collection plus volatility trading, to premium collection plus volatility trading plus upside trend-following price-wise.”

Walczak uses all three approaches but emphasizes the one appropriate to market conditions. “I can construct a spread that gives me the exposure I want. It is not a make-it-up-as-you-go-along [approach], we have established position templates for different types of market environments. If I want to go long volatility, I don’t scratch my head and say, ‘What do I do now?’ We go into our tool box and pull out the long volatility spread and do some analysis around where to put that on.” It is a combination of a discretionary and systematic approach that has produced solid returns in different market environments. Harbor has had no losing years and has produced a compound annual return of 22.07% with a 1.22 Sharpe ratio, and Walczak is still making improvements.

*  *  *

So major leverage on billions of AUM and a look at the unprecedented ramps in US equity markets over the last few years shows that perhaps Walczak and his fund did not fully figure out the "problems in sharply uptrending markets."

The Bullard Bounce?

The Brexit Bounce?

 

The Trump Bounce?

Of course, Walczak's strategy is not alone and if not the catalyst it is these levered options strategies that are the reflexive forced buyer that appears to be driving such self-reinforcing and seemingly incredible moves in stock markets as volatility has collapsed and the cost if funding massively levered strategies is de minimus. In a different world of considerably lower leverage, LTCM nearly blew up the world; in the new normal of as-much-leverage-as-you-can-eat, even a mid-sized fund's positions can be the butterfly that flaps its wings and become the forced 'ax' in world equity markets... even if it doesn't know it.

Just how much of the last 150 S&P points are due to the liquidation of 'Catalyst' (and strategies like it)?

As RBC's Charlie McElligott warned:

This equities upside short-gamma grab has taken out a ton of ‘bid on the downside’ in equities index, in the case that we were to see any sell-off post a Trump speech disappointment.  This lack of cover-demand on a vacuum-move could see sloppiness develop, as it seems that the data and Fed itself are no longer dictating the market story at this stage - whether stocks, fixed-income or vol.  “Policy” is now firmly “in the driver’s seat,” and that is where I see the least degree of confidence in the market.

 

I’m worried that this stock ‘melt-up’ move is extraordinarily mechanical right now - almost entirely the aforementioned forced-covering, not high conviction induced-buying - and may be sending a “false signal” which is potentially dragging-in new buying on the breakout to new highs.

As he concludes: "This could lead to a scenario where a market can “collapse under their own weight."

Indeed, because if one removes the forced buying from the "blowing up fund", there is certainly a long way down.

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Soul Glow's picture

Someone tell him to BTFD!  We can't have any red days under the Tweeter in Cheif!

BabaLooey's picture

So.............if THIS GUY....

Dies..........."expires worthless"

Is taken out

Is comprimised........

THEN WE ALL GO TO SHIT.........

.................oh.....wait wait don't cuck me...............

It's ..........a casino.

Vive O' Festivale~

 

Fizzy Head's picture

Introducing the next 'patsy'.... as if this one dude can make or break the trillion dollar ponzi scheme. pffft.

I was born in the morn, but not yesterdat morn.

Serfs Up's picture

"Markets" indeed.

One wonders...did this guy also buy every freakin' index across the entire world?

Because if not, I am calling BS on this fat finger story.

It's the central banks doing this level of sustained panic buying.  Not a single, miniscule fund.

NugginFuts's picture

Think about it a different way: 1) Every time Trump tweets or hiccups the word "tax cuts", the algorithms go on a buying spree. 2) Every buying spree triggers more of option covering by Catalyst. 3) Trump takes credit for the positive market response, so he says "tax cuts" even more, triggering more buying.

The dog is eating his own tail this morning. 

hedgeless_horseman's picture

 

The government-approved software that powers such machines markets gives the house banks a fixed mathematical edge, so that casinos banks can be certain of how much they’ll earn over the long haul

I am certain that the global financial system has been hacked far more than slot machines.  The shrinkage must be the equivalent of billions if not trillions of electronic USD / year.

When the scheme fails, the banks get bailed out, as long as they keep sending money to the politicians.

Privatize the gains, socialize the losses.  Same as it ever was.

lasvegaspersona's picture

hedgers pleeze...no thinkin here...we are seeing magic!!

lasvegaspersona's picture

hedgers pleeze...no thinkin here...we are seeing magic!!

NugginFuts's picture

Update: Trump news conference at 12 EST. I wonder if we'll hear the words "tax cuts" again. Love to see this bubble float to the moon before it bursts.

Hammer823's picture

Buying the dip and selling the same day has generated the best return for me by far

Over the years I have bought and held, traded options and the like.

Nothing, absolutely nothing, has come close to the returns from buying and selling the dips the same day.

https://www.instagram.com/the_rigged_street_journal/?hl=en

LawsofPhysics's picture

"market" LMFAO!!!!

Stop it. But yes some recent bets are definitely paying off!  Now carry on!  (cash out that dollar carry trade now, don't be greedy!)

gatorengineer's picture

The carry trade has only just begun.... if its looking like LePen, and Older Yeller Raises, this thing is gonna fly.

Squid Viscous's picture

Walczak, meet lamp-post and rope

small axe's picture

no redemption value in this man

vesna's picture

where is shalom bernanke?

NugginFuts's picture

Hopefully the breaking of this news is enough to cause Catalyst's investors to withdraw their funds immediately. That would make the situation even worse and the implosion that much more entertaining.

A. Boaty's picture

No longer getting inside info from big (D)?

The Real Tony's picture

If there ever was a reason to bring back the electric chair this is the reason. Hang drawn and quartered is too good for him.

buzzsaw99's picture

that was interesting. thank you.

angry_dad's picture
angry_dad (not verified) Feb 16, 2017 10:13 AM

Forget this gibberish!

The #1 reason behind the market ramp up is;

The chimp's 8 year reign of negative GDP growth is over.

Now people have enough confidence to buy and invest without fear of another economic collpase, a give away, or bailout for crooks.

 

LawsofPhysics's picture

Really? LOL!  Well, glad to see another optimist. How's that 20 trillion dollar debt going to be dealt with, or are you one of those "debt doesn't matter" types?  If so, then good luck with that cognative dissonance.

EX-floor hedger's picture

how about the option "squish" strategy???

sell two out of the money calls for a credit, and buy an at the money put...if you're wrong....you're squished...

hotrod's picture

So one guy moves a 26 trillion dollar market.

syzygysus's picture

pffft, its the PPT printing 1's and 0's like 10000 monkeys on typewriters and buying equities from their overseas accounts.

LawsofPhysics's picture

Yep.  It certainly is consistent with the "market" rise and rise in the dollar.

Barney08's picture

Can this thing work in reverse? HA!

MrBoompi's picture

Oh look, it's a $21 trillion stock market being led around by a $4 billion hedge fund!

gatorengineer's picture

If he were levered he would loose all of it in days.... again, this is not the roid you are looking for.

BlueHorseShoeLovesDT's picture

So in your world options don't have leverage. Pretty fucking stupid aren't you.

pound the vix's picture

Looks like he was simply long the VIX and got his ass kicked while the rest of wall street pounds the VIX

buzzsaw99's picture

to all you fucks disparaging this guy. he isn't goldman sachs. he made his chops by being smart. we should be happy when a guy does okay on his wits alone. when he is wrong, he pays the price. the maggots we should hate are the ones who never lose and even when they do lose they get a public bailout from the fed or the usa gubbermint. some of them (the squid, jpm) actually run the fed and the usa gubbermint. this guy is NOT one of THEM or he wouldn't be losing right now so stfu and stop hating on this minnow.

Market Rage's picture

Agree.  If the markets were allowed to function properly we'd be reading about how much bank this guy is raking in.

buzzsaw99's picture

+1 he is scratching around in THEIR KITTY BOX and banking coin anyway.

Good for you Jack.

https://www.youtube.com/watch?v=q1YOAmIVMhU

that's like those semi-pro poker players in las vegas playing ten hours a night eking out a living by taking a few hundred off the tourists every night.

Good for you Jack.

spastic_colon's picture

ya ok I agree with this.....but deleting my comment sort of defeats the purpose of ZH and fight club.....there must be a bot out there searching for words like "fake" or the like and reporting them to internet police and scoring websites.

Overleveraged_and_Impatient's picture

This is why ZH will forever be my favorite REAL NEWS site. Excellent research and reporting. Ads are ridiculous though but worth it.

DTP's picture

This is setting up a chain reaction (like a slow-motion train wreck)- XIV (inverse VIX) is going to be the next cog- already happening, but spooze is still ignoring it atm; blow off top in XIV 2 days ago, with a lot of people heading for the exits as we speak.  These idiots crammed into this thing as vol got crushed during the short covering over the last few days- vol was pushed so low that there is going to be a massive reflexive rebound over the next 3-5 days- OPEX may get really interesting tomorrow- Black Friday or Black Monday anyone?

Mark of Zerro's picture

Is this article written up correctly?  How do you sell a front month contract and buy a back month contract for a credit?  (I'm assuming he's selling a put/buying put and selling calls/buying calls to define his risk.)  If he's not doing this then....?    

ahhh...re-read:  1 x 4 and 1 x 5 call spreads

youngman's picture

For some reason Czech ladies showed up on my screen with this guy....lol

but anyway...I ahd an uncle who used to go to Las Vegas all the time..he had a system.....he said he won lots of money...but he was always asking my dad for money...go figure

all-priced-in's picture

It looks like one of his investors has already punched him in the mouth -

 

Sure looks like he has a fat lip to me.

 

 

buzzsaw99's picture

the guy has had two losing years in ten. now if ackman had a fat lip, that i could understand. the fat lip is probably from his wife. lulz

DTP's picture

edit- answered own question