Amaranth Advisors
In September 2006, hedge fund Amaranth Advisors lost about $6 billion on natural gas futures spreads. Learn the trades, why they failed and the risk lessons.
Amaranth Advisors was a multi strategy hedge fund that, by 2006, managed about $9 billion. Much of its profit came from energy trading led by Brian Hunter, a natural gas trader based in Calgary. In September 2006, natural gas spreads moved sharply against his enormous positions, and Amaranth lost roughly $6 billion within weeks, one of the largest hedge fund collapses in history. Unlike LTCM, the failure did not threaten the wider system, but it remains a classic case study in concentration, liquidity and the danger of a single trader dominating a firm's risk.
The trades#
Hunter's main positions were calendar spreads in natural gas futures, bets on the price difference between contracts expiring in different months. See Calendar Spreads in Futures.
| Position | Bet |
|---|---|
| Long winter contracts (such as March 2007) | Winter gas would stay expensive due to heating demand |
| Short spring contracts (such as April 2007) | Spring gas would be cheaper as demand falls |
| Net effect | The March to April spread would stay wide or widen |
Spreads like this widened sharply in 2005 after Hurricanes Katrina and Rita disrupted supply, and Hunter's similar bets had produced large profits. In 2006, he expected another tight winter.
What went wrong#
| Factor | Explanation |
|---|---|
| Mild conditions | No major hurricane disruptions and high storage levels reduced fears of winter shortages. See Storage and Inventories |
| Spread collapse | The winter to spring spreads narrowed sharply |
| Concentration | Energy positions dominated the fund's risk. See Concentration Risk |
| Size | Amaranth held a very large share of open interest in some contracts, making exit difficult. See Open Interest |
| Liquidity | Selling such large positions pushed prices further against the fund. See Liquidity Risk |
| Leverage | Futures margin allowed huge exposure relative to capital |
The collapse#
By mid September 2006, losses had reached several billion dollars. Amaranth sold its energy portfolio to JPMorgan and the hedge fund Citadel at a steep discount, and the fund began winding down. Investors, including pension funds, lost heavily.
Regulatory aftermath#
The CFTC and the Federal Energy Regulatory Commission later brought cases related to Amaranth's trading, alleging attempted manipulation of natural gas settlement prices. A US Senate investigation concluded that Amaranth's positions were so large they had influenced prices and that trading on less regulated electronic venues allowed it to avoid exchange position limits. The case contributed to calls for stronger position limits in energy markets. See Position Limits and Regulatory Reporting.
Lessons#
- Spread trades are not automatically safe; size and leverage matter.
- One trader or strategy dominating risk is a concentration problem for any firm.
- Being a large share of a market means you cannot exit quickly.
- Past success can lead to larger bets just before conditions change. See Overconfidence.
- Risk limits must apply to star performers too. See Risk, Position, Loss and Drawdown Limits.
Frequently asked questions#
What happened to Amaranth Advisors?#
The hedge fund lost about $6 billion in September 2006 on natural gas futures spreads and was wound down.
Who was Brian Hunter?#
Amaranth's lead natural gas trader, whose large calendar spread positions produced big profits in 2005 and the fund's collapse in 2006.
Why did Amaranth's trades fail?#
Winter to spring natural gas spreads narrowed sharply amid high storage and calm weather, and the fund's huge positions could not be exited without large losses.
Next, learn about a more recent leverage blowup in Archegos Capital.
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Mentioned in
- The Fall of Barings BankMarket History
- Hedge FundsThe Trading Industry