Results of a Proprietary Model Applied to Commodity Futures

Robert T. Samuel III This Version: 17 September 2013

Summary of Analysis

We test a proprietary momentum-based model rst discussed in Samuel (2013) upon sixty U.S. exchange-traded commodity futures. Our results show that the model outperforms three competing models for a variety of statistics. Specically our model has largest net prots and highest annualized total return.

Description of Data

We utilize back-adjusted and spliced prices for sixty, U.S. exchange-traded commodity futures, listed in Tables 1 & 2, with varying start dates dependent on data availability and ending on 22 February 20131 . In cases where there are both the pit-traded futures and combined pit-and-electronic futures, we use the latter which is denoted as Combined in the tables. In addition to this data we also collate contract multiplier, length of trading day (minutes), and exchange fees via Norgate and exchange websites23 . Lastly, again using exchange website sources, we create a margin multiplier that is multiplied against the prevailing contract value so as to derive an estimate of the contract
Correspondence: rtsamuel3@gmail.com Initial Version: 31 August 2013. Changes in this version are the inclusion of rolls and exchange fees in simulated results; the removal of Continuous Commodity Index (CI2), Robusta Coee (LRC2), White Sugar (LSU2) and CBOE Volatility Index (VX2) from the list of futures tested; and more explicit motivation for the commission, fee and slippage estimates. 1 Data is from Norgate Investor Services (Norgate) [http://www.premiumdata.net/] and they provide an explanation of the meaning of, and dierences between, back-adjusted and spliced prices at [http://www.premiumdata.net/support/futurescontinuous.php] 2 In the case of length of trading day, if there are two sets of trading hours we use the smaller of two numbers since we utilize the length of trading day when calculating our slippage estimate: specically the length is the denominator of a scalar and therefore by using a smaller number, we create more conservative slippage estimates. 3 In the case of exchange fees, if there are dierent tiers, we utilize fees for non-member speculators.

margin for a specic date. In cases where we are able to acquire historical margin rates, we use linear regression to calculate the margin multiplier4 . Specically, we solve the equation Mt = CVt + (1)

where Mt is the margin value, CVt = Pt CM is the contract value derived from the Pt , futures price, and CM , contract multiplier, and is our estimate of the margin multiplier all at time t5 . In cases where we cant nd historical margin rates, we make a simple estimate of M (2) MM = CV where the variables are the same as from (1) and M M is our estimate of the margin multiplier.

Models Tested

We test four models: our proprietary model (Model), a model that combines three moving average crosses (MAC), a momentum model (Mo) and a buy & hold model.

3.1

Model

Our proprietary model is a modied momentum model that yields a real value output. With this output, our trade signal becomes St = where t is our model output at time t. Buy Sell if t >= 0 otherwise (3)

3.2

MAC

Our rst competing model is a combination of three moving average crosses. Let (i, j ), i(i < j ) be a parameter tuple, then a moving average cross sub-model is of the form M AC (i, j )t =
4

(4)

ti1 1 if 1 k=t Pk >= i 0 otherwise

1 j

tj 1 k =t

Pk

(5)

We note that some futures exchanges specically state that they use other variables when determining contract margin (I.e. CME states that they use volatility when computing margin requirements). However, when performing the estimation, the linear regression(s) yielded high R-squared(s) which, given the data, supports our proposed structural form. 5 Note, we omit the intercept term as from a theoretical standpoint it should not exist as we would expect an exchange to set zero margin requirements for a future trading at, or near, a zero price.

where Pt is the back-adjusted closing price at time t. Then our model is the average of the constituent sub-models, M ACt = Buy Sell
n 1 if n m=1 M AC (m)t >= otherwise 1 2

(6)

where n is the number of sub-models and m delineates a parameter tuple within the set of parameter tuples. For our simulation we select three sub-models with parameter tuples of (50,100), (50,150) and (50,200) as we desire a competing model with low turnover and a long time horizon.

3.3

Mo

Our second competing model is a simple momentum model which we dene as M ot = Buy Sell if Pt >= Ptx otherwise (7)

where Pt is the same as before and x = 251 is a user-specied horizon which is selected as prior research has shown this to be an optimal time horizon6 .

3.4

Buy & Hold

Our last competing model is a simple buy & hold model which takes a long position in each commodity for the duration of their respective time series7 . This model represents a naive investment approach and is included so as to estimate the nominal returns oered by each commodity.

Back-testing Simulation

We code a back-testing algorithm using C# that outputs trade statistics for all commodity futures listed8 . This algorithm performs specic steps and with certain assumptions which we list below: We trade based upon the trade signal from the previous, t 1, day. We trade one contract throughout the simulation (there is no compounding of returns). Margin-to-Equity (ME) of 15% is used when calculating initial capital outlay per trade9 . Therefore, after calculating our estimate for the initial margin we adjust this
Baltas & Kosowski (2012) and Moskowitz et al (2012) provide thorough research on this subject. We do not fully collateralize the position as is the norm but use the specied capital based upon our margin estimate and the margin-to-equity rate. This is done so as to facilitate comparisons with the other models which are not fully collateralized. 8 C# is an object-oriented programming language developed by Microsoft. 9 Diz (2003) analyzed CTAs for the period of 1974-1998 and found an average ME of 19.40%. Given this research we view 15% as a conservative ME.
7 6

amount by our ME and this nal amount becomes the divisor when calculating trade returns. We assume that there is enough volume to transact if we get a trade signal (I.e. there is no volume check). Commission of $10 per side, $20 round-turn throughout10 . Variable slippage estimate based upon an instantaneous volatility estimate from Parkinson (1980). Namely, let t =
Lt 2 t ) log( O )) (log( H Ot t

(2 log(2) 1) 2 log(

Ct ) Ot

(8)

be our instantaneous volatility estimate, t , where Ht is the high price, Ot is the opening price, Lt is the low price and Ct is the closing price using actual prices from our spliced prices data series. Then our slippage estimate is t1 t,M = x (9) (M ) where x is a user-specied amount of time, in minutes, and (M ) is the length, in minutes, of the trading day for the M th commodity future. For our simulation, we let x = 30 as we expect this to be sucient amount of time to transact on a specic day11 . We assume that opening and closing trades are combined and therefore have the same slippage-adjusted price. I.e. if we are long one contract and are given a sell signal, we sell two contracts at the same price. Rolls are incorporated with additional trades conducted on specied dates and on these days we also recalculate the capital amount utilized to calculate per trade returns12 . Fees are included for each trade using commodity-specic fee amounts13 .

Discussion of Results

Listed in Table 3 we see summary statistics from the back-testing simulation for each model. In it we see that for most statistics our model outperforms the three competing benchmark
This estimate is high relative to current commission rate(s) but as these are simulated results, the conservative estimate is seen as providing more robust simulated results. 11 Note, we do not allow the volume of trading for a specic trading day impact x. We acknowledge this limitation and as we perform more research, we will adjust this accordingly. 12 Norgate employs a xed schedule for rolls as opposed to a data dependent schedule. Information on their approach and philosophy can be found at [http://www.premiumdata.net/support/futurescontinuous3.php] 13 The fees utilized are current fees and they may be lower than prior fees due to exchange competition and technological changes. Therefore models with a higher propensity to trade will be advantaged; but without any information on historical fee rates, we employ the current fees throughout our simulation(s).
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models. Specically, it has the largest net prots and highest annualized total return14 . Given these statistics, it appears that our model benets from the presence of long-term trends. However, given that it also makes a prot on the highest proportion of commodities signies that its results are not skewed by the success of a few commodities. In addition, although we do not report the statistic, we perform a Mann-Whitney-Wilcox test [Mann & Whitney (1947)] with the null hypothesis of equality and an alternate hypothesis of a greater-than inequality. For all tests we reject the null when comparing our proprietary models returns with all three competing models which signies that, based upon the data, the model has stochastically greater-than returns when compared to the other competing benchmark models. Lastly, in Tables 4 & 5 we list the annualized total returns for each commodity using a specied model. In these tables we can see that our proprietary model outperforms the other benchmark models for 30% of the futures versus 47% for the Buy & Hold model. Therefore, although the model has the highest annualized total returns overall this does not translate to all futures tested.

Conclusion & Further Research

Given the data, our proprietary model shows strong results that are broad-based and should be robust to changes in the assumed structure of slippage, commissions, margin and exchange fees. However, we have not tested the performance of the model within a portfolio framework and therefore do not understand the correlation structure of the trading signals. Therefore our continued research will deal with understanding the proper usage of the trading model in constructing portfolios of commodity futures.

References
[1] Baltas, A-N. and Kosowski, R. (2012) Momentum Strategies in Futures Markets and Trend-following Funds [2] Diz, F. (2003) Commodity Trading Advisors Leverage and Reported Margin to Equity Ratios [3] Mann, H. and Whitney, D. (1947) On a Test of Whether one of Two Random Variables is Stochastically Larger than the Other, Annals of Mathematical Statistics 18(1), 50-60 [4] Moskowitz, T., Ooi, Y., and Pedersen, L. (2012) Time series momentum, Journal of Financial Economics 104(2), 228-250
14 For annualized total return we use the average trade return and average trades per year to calculate the statistic. Specically, let x M be the average trade return for the M th commodity, then M RM = (1 + x M )y 1

(10)

is the annualized total return given y M , the average number of trades per year.

[5] Parkinson, M. (1980) The Extreme Value Method for Estimating the Variance of the Rate of Return, The Journal of Business 53(1), 61-65 [6] Samuel, Robert (2013) The Analysis of a Momentum Model and Accompanying Portfolio Strategies

Ticker AC AD BO2 BP C2 CC2 CD CL2 CT2 DA DJ2 DX2 EC ED EMD ES FC FF2 FV2 GC2 GI HG2 HO2 JY KC2 KW2 LB LC LH MP

Description Ethanol Australian Dollar Soybean Oil- Combined British Pound Corn- Combined Cocoa- Combined Canadian Dollar Light Sweet Crude Oil- Combined Cotton #2- Combined Class III Milk DJIA ($10)- Combined U.S. Dollar Index- Combined Euro FX Eurodollar E-mini S&P MidCap 400 E-mini S&P 500 Feeder Cattle 30 Day Federal Funds- Combined 5-Year U.S. Treasury Note- Combined Gold- Combined S&P GSCI Copper- Combined Heating Oil- Combined Japanese Yen Coee C- Combined Hard Red Winter Wheat- Combined Random Length Lumber Live Cattle Lean Hogs Mexican Peso

CM $29,000 $100,000 $600 $62,500 $50 $10 $100,000 $1,000 $500 $2,000 $10 $1,000 $125,000 $2,500 $100 $50 $500 $4,167 $1,000 $100 $250 $250 $42,000 $125,000 $375 $50 $110 $400 $400 $500,000

MM 0.031 0.035 0.054 0.019 0.067 0.047 0.02 0.078 0.044 0.049 0.069 0.012 0.022 0.004 0.042 0.053 0.028 0.001 0.009 0.053 0.047 0.067 0.062 0.028 0.06 0.077 0.045 0.032 0.045 0.097

Length 270 400 270 400 270 480 400 330 480 305 405 480 400 400 405 405 295 400 400 310 345 310 330 400 480 270 305 295 295 400

Fees $1.45 $1.05 $1.3 $1.05 $1.3 $2 $1.05 $1.45 $2 $1.3 $1.55 $1.35 $1.05 $0.6 $0.8 $0.8 $1.3 $0.6 $0.6 $1.45 $1.55 $1.45 $1.45 $1.05 $2 $1.9 $1.3 $1.3 $1.3 $1.05

Start Date 4/28/2006 1/13/1988 11/28/1980 12/10/1980 11/28/1980 8/13/1981 12/10/1980 4/13/1984 11/13/1980 7/9/1998 10/7/1998 12/10/1986 1/6/2000 1/31/1983 1/29/2003 9/15/1998 10/24/1980 10/3/1989 5/22/1989 11/25/1980 6/9/1997 11/25/1980 11/26/1980 12/10/1980 11/18/1980 11/19/1980 11/3/1980 11/25/1980 11/25/1980 4/23/1996

Table 1: Ticker symbols, contract descriptions, contract multipliers (CM), margin multipliers (MM), length of trading day (in minutes), exchange fees and start dates for futures tested in back-testing simulation.

Ticker MW2 ND NE NG2 NK NQ O2 OJ2 PA2 PL2 RB2 RF RR2 S2 SB2 SF SI2 SM2 SP TF TU2 TY2 UL2 US2 W2 YG YI YM ZG ZI

Description Hard Red Spring Wheat- Combined NASDAQ 100 New Zealand Dollar Henry Hub Natural Gas- Combined Nikkei 225 Dollar E-mini NASDAQ 100 Oats- Combined FCOJ A- Combined Palladium- Combined Platinum- Combined New York Harbor RBOB Gasoline- Combined Russell 1000 Mini Index Rough Rice- Combined Soybeans- Combined Sugar #11- Combined Swiss Franc Silver- Combined Soybean Meal- Combined S&P 500 Russell 2000 Mini Index 2-Year U.S. Treasury Note- Combined 10-Year U.S. Treasury Note- Combined Ultra Treasury Bond- Combined 30-Year U.S. Treasury Bond- Combined Wheat- Combined mini-sized Gold mini-sized Silver E-mini Dow ($5) 100 oz Gold 5000 oz Silver

CM $50 $100 $100,000 $10,000 $5 $20 $50 $150 $100 $50 $42,000 $100 $20 $50 $1,120 $125,000 $50 $100 $250 $100 $2,000 $1,000 $1,000 $1,000 $50 $33.2 $1,000 $5 $100 $5,000

MM 0.057 0.098 0.034 0.124 0.078 0.041 0.081 0.113 0.058 0.057 0.07 0.035 0.056 0.062 0.05 0.027 0.046 0.064 0.073 0.05 0.004 0.014 0.036 0.023 0.083 0.07 0.101 0.041 0.07 0.101

Length 480 405 400 330 405 405 270 360 310 310 330 480 270 270 480 400 310 270 405 480 400 400 400 400 270 480 480 480 480 480

Fees $1.8 $1.55 $1.05 $1.45 $1.55 $0.8 $1.3 $2 $1.45 $1.45 $1.45 $1.14 $1.3 $1.3 $2 $1.05 $1.45 $1.3 $1.55 $1.14 $0.6 $0.6 $0.6 $0.6 $1.3 $0.84 $0.84 $0.8 $1.09 $1.09

Start Date 11/28/1980 6/12/1997 12/12/2007 4/18/1991 9/25/1991 6/20/2000 12/2/1980 10/28/1980 8/29/1983 9/26/1980 11/30/2006 6/13/2008 10/27/1989 10/29/1980 9/18/1980 12/10/1980 11/25/1980 11/28/1980 4/20/1983 10/25/2002 6/24/1991 5/4/1983 1/10/2011 12/1/1980 11/28/1980 6/13/1985 11/26/1984 4/7/2003 10/10/2005 10/10/2005

Table 2: Ticker symbols, contract descriptions, contract multipliers (CM), margin multipliers (MM), length of trading day (in minutes), exchange fees and start dates for futures tested in back-testing simulation.

Model MAC Mo Buy & Hold Total Prots $15,165,156.11 $15,586,664.64 $16,502,298.97 $13,448,165.92 Number of Protable Trades 4,965 5,221 6,164 4,049 Percentage of Protable Trades 50.58% 48.64% 38.78% 49.85% Average Return on Protable Trade 20.82% 20.19% 18.55% 23.36% Total Losses -$12,763,048.94 -$13,535,355.47 -$16,990,458.08 -$12,187,792.12 Number of Losing Trades 4,852 5,514 9,730 4,073 Percentage of Losing Trades 49.42% 51.36% 61.22% 50.15% Average Return on Losing Trade -17.89% -16.72% -11.81% -19.59% $2,402,107.17 $2,051,309.17 -$488,159.11 $1,260,373.80 Net Prot & Loss Total Number of Trades 9,817 10,735 15,894 8,122 Average Trade Length 37.13 33.95 22.93 44.87 Average Trade Slippage 0.49% 0.49% 0.50% 0.49% Number of Protable Commodities 49 47 24 40 Average Number of Trades per Year 6.79 7.42 10.99 5.61 Average Trade Return 1.69% 1.23% -0.04% 1.82% Standard Deviation of Trade Return 28.85% 27.61% 23.32% 31.58% Skewness of Trade Returns 0.73 0.94 1.33 0.95 Kurtosis of Trade Returns 8.80 9.42 14.71 7.77 12.02% 9.52% -0.42% 10.68% Annualized Total Return
Table 3: Aggregate statistics from back-testing simulation.

Model MAC Mo Ethanol -8.21% 4.81% 62.77% Australian Dollar 11.59% 10.08% 5.15% Soybean Oil- Combined -3.37% 3.81% -15.19% 4.81% 5.86% -24.07% British Pound Corn- Combined -1.87% -7.44% -13.11% -19.36% -10.19% -46.92% Cocoa- Combined Canadian Dollar 5.98% 12.88% -7.31% Light Sweet Crude Oil- Combined 8.73% 9.35% -11.72% 35.12% 33.28% 11.72% Cotton #2- Combined Class III Milk 40.09% 40.03% 12.99% DJIA ($10)- Combined -0.56% -6.63% -6.55% 18.03% 7.38% -19.83% U.S. Dollar Index- Combined 11.05% 24.24% -19.27% Euro FX Eurodollar 34.75% 38% 29.53% E-mini S&P MidCap 400 8.6% 24.79% -8.26% E-mini S&P 500 9.66% 6.75% -3.88% Feeder Cattle 5.95% -11.61% -4.82% 35.86% 22.47% 63.95% 30 Day Federal Funds- Combined 16.94% 28.7% 5-Year U.S. Treasury Note- Combined 33.72% Gold- Combined 12.29% 8.09% -2.91% S&P GSCI 27.21% 23.16% 22.53% 17.90% 20.68% 8.02% Copper- Combined Heating Oil- Combined 0.02% -4.77% -1.84% Japanese Yen 16.01% 2.77% 19.99% Coee C- Combined 14.22% 12.47% -18.56% Hard Red Winter Wheat- Combined 7.55% 1.84% -5.91% Random Length Lumber 32.38% 20.82% 58.39% Live Cattle 10.56% -7.18% 9.4% Lean Hogs 5.16% -17.65% -11.14% Mexican Peso 0.76% -0.49% -1.51%

Buy & Hold 202.56% 21.09% -6.18% 6.03% -8.81% -16.48% 10.45% 22.37% -0.64% -0.56% 11.46% -23.08% 16.98% 48.77% 47.95% 8.8% 8.29% 114.92% 61.98% -3.63% 9.73% 20.14% 36.52% 0.28% -3.01% -0.48% -23.39% 13.56% -0.51% 9.36%

Table 4: Annualized total returns for specied commodities and models.

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Model Hard Red Spring Wheat- Combined 7.75% NASDAQ 100 19.21% New Zealand Dollar -13.43% 8.96% Henry Hub Natural Gas- Combined Nikkei 225 Dollar 8.69% 22.6% E-mini NASDAQ 100 Oats- Combined 1.94% FCOJ A- Combined -1.52% 48.13% Palladium- Combined Platinum- Combined 6.77% New York Harbor RBOB Gasoline- Combined -0.81% 52.91% Russell 1000 Mini Index 16.38% Rough Rice- Combined Soybeans- Combined 5.44% Sugar #11- Combined 0.09% Swiss Franc 7.91% Silver- Combined 24.02% 28.25% Soybean Meal- Combined 7.38% S&P 500 Russell 2000 Mini Index 4.95% 2-Year U.S. Treasury Note- Combined 68.39% 14.91% 10-Year U.S. Treasury Note- Combined Ultra Treasury Bond- Combined 48.53% 30-Year U.S. Treasury Bond- Combined 7.76% Wheat- Combined 5.52% mini-sized Gold 3.66% mini-sized Silver 3.32% E-mini Dow ($5) 13.82% 100 oz Gold 4.45% 5000 oz Silver 27.02%

MAC Mo Buy & Hold 19.12% 27.36% 16.45% 24.53% 8.27% 14.5% 3.12% -13.1% 26.56% 12.33% 0.95% -13.73% 3.37% 2.18% -4.08% 48.97% -11.34% -3.44% 6.95% -15.76% -4.94% 1.05% -5.79% 3.72% 39.55% 18.31% 27.75% 3.82% -12.66% 6.92% 19.02% -15.88% 69.69% 48.23% 16.54% 33.85% 14.96% -24.03% -14.39% 0.56% -11.92% 5.15% 19.16% -28.2% -5.34% 16.27% 17.22% 2.59% 10.64% -2.56% 1.01% 19.82% 18.82% 16.45% 2.83% -2.93% 14.12% -5.25% -16.24% 37.56% 60.93% 53.59% 76.64% 14.66% 19.17% 58.28% 2.36% 45.6% 74.66% 9.18% 0.66% 42.14% -8.71% -3.15% -10.32% 2.33% -7.09% 4.26% -1.09% -4.66% 3.90% 9.07% 3.51% 26.99% 23.08% -5.24% 37.07% 12.06% 12.11% 39.60%

Table 5: Annualized total returns for specied commodities and models.

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