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Smart trades that have made this a good year for some


Date: Thursday, December 21, 2006
Author: Gillian Tett, FT.com

When Brian Hunter, a gas trader at Amaranth Capital, made a terrible bet on gas futures earlier this year, the news of his $6bn losses mesmerised the markets.

What received less attention - partly because it was well hidden - were those who were benefiting from Amaranth's pain. Centaurus Capital, another hedge fund, for example, has reportedly notched up a bumper year, partly because it took canny bets on the other side of the Amaranth trade.

Meanwhile, JPMorgan and Citadel, another US fund, have also made profits in recent months by buying some of Amaranth's losing positions at knock-down prices - and then riding them well.

The saga reveals two important points about financial markets: namely, that for every great loss there is invariably a win somewhere. However, those who make brilliant trades are often reluctant to reveal them - out a fear of attracting either jealousy, attention from the taxman, or simply a bout of bad luck.

"One thing you learn as a trader is that no matter how much skill there is, there is also a lot of luck," says Satyajit Das, a former trader and author of Traders, Guns and Money. "Often successful traders cannot explain themselves exactly how they made money."

Consequently, although trading makes the financial world go round, getting bankers to reveal some of their most successful trading gambits remains a remarkably difficult task.

Where have some of the more sparkling trades recently emerged? One fertile stamping ground has undoubtedly been the commodities world, where opportunities have abounded for sharp investors - even without the Amaranth debacle.

Redkite, the secretive hedge fund based in London and New York, for example, has apparently made a killing this year by betting on the rising price of copper. So has Touradji, another commodity fund, which is famed for taking ultra-aggressive bets.

In the equities world, one of the smartest trades in the year was to predict the collapse of internet gaming stocks such as World Gaming and SportingBet. According to Trader Monthly, Kynikos Associates, the hedge fund run by Jim Chanos, was apparently one of those that did so.

Another smart bet was made by some of the investors involved in the international public offering of Beijing's Industrial and Commercial Bank of China. Trader Monthly estimates that Goldman Sachs made $4bn in just six months by taking a 7 per cent stake in bank before its flotation - although the US bank only admits to a $1bn gain from the sale.

In the credit sector, profits have been taken by some funds playing the new "event arbitrage" game - or the practice of placing speculative bets in the credit default swaps market based on whether companies will retire their debt early.London-based Cairn Capital, for example, took winnings on such a bet involving GUS, the UK retailer and credit-checking business that demerged.

Rich pickings have also been found in the credit carry trade, given that the cost of funding has fallen this year far further than even the most optimistic credit analysts were predicting at the start of the year. Or, as one senior banker says: "Anyone sitting on CDO equity had a great trade this year."

But clever deals have also cropped up in some seemingly dull backwaters. As Lawrence Mutkin of Morgan Stanley points out, investors who bet on the flattening of the eurozone yield curve have enjoyed a stellar year. Another trade that has benefited groups such as Pimco is the so-called "negative basis" trade - a strategy that takes advantage of the fact that the recent fad for creating complex financial instruments has caused derivatives prices to swing relative to bonds.

Another solid performer until the past couple of months was a bet placed on the difference between the price of implied and realised volatility in the US: Lehman Brothers is one group that has promoted this trade heavily in recent years.

In emerging markets, some hedge funds "made a killing by hoovering up Mexican and Brazilian assets" when those markets tumbled this spring, one banker says. More recently, Venezuelan banks are believed to have been the winners of the recent sharp swing in the cost of buying credit protection against a default on Ecuadorian bonds.

But although these trades will undoubtedly have produced some fat returns - or bumper bonuses - for those involved, it is doubtful whether they will look that spectacular in a longer term view. For what has really marked out 2006, above all else, is that volatility has been very low in most asset classes.

Thus the $1bn-odd profits that George Soros reaped by betting against the pound in 1992 - or the $300m gains Paul Tudor Jones enjoyed after the 1987 equity crash - have never emerged.

Nevertheless, some investment banks are now predicting - or hoping - that markets could become more turbulent in 2007, particularly if the dollar continues to fall. If so, that could spell trouble for some investors who have recently bought highly leveraged instruments. However, it could also make 2007 a much more exciting year - at least for the traders.

In the coming days, the FT Capital Markets pages will be running a series called Sparkling Trades, outlining some of the cleverest - or luckiest - strategies seen in recent years. The topics covered will include: the negative basis trade between cash bonds and derivatives; the Chandler Brothers' bet in Japan; bets on internet gaming stocks; and trading on the restructuring of Drax