Amaranth Advisors

Date: 2006   /   Region: AMER
Published February 1st, 2017
Ron Rimkus, CFA

The Amaranth Advisors collapse is the story of an aggressive trading strategy that not only failed but also took the company down with it. Brian Hunter, head of trading at hedge fund Amaranth Advisors, bet over 50% of the firm’s assets under management on one set of trades. In essence, Hunter observed a historical pattern in the prices of different natural gas contracts based on their expiration month. An unexpectedly mild winter, however, threw his portfolio into a state of chaos. Once the trades started going south, the firm was unable to exit its positions. In a matter of weeks, Amaranth Advisors collapsed. Although certain questions remain unanswered, it is clear that Hunter acted imprudently.

Analysis and Commentary

The crisis at Amaranth Advisors was caused by a single package of trades that went wrong. Using what is known as a “calendar spread strategy,” head energy trader Brian Hunter bet that the spreads between winter-month natural gas contracts and non-winter-month contracts would widen. Instead, they shrank. Using futures and options, Hunter bet more than half the firm’s capital on this single thematic idea. And because the firm bet so many of its assets on this one trade, it apparently prepared for only one scenario: we’re right and the market is wrong. Whatever the exact rationale, the strategy was highly aggressive and it failed.

There are (at least) two ways to look at this tragic trade — (1) as a single investment decision that would either succeed or fail on its own merits or (2) as one component in a broad trading strategy based on exploiting market anomalies. As a single investment decision, Hunter’s strategy failed to have a sound basis. Even though a back-tested version of the calendar spread strategy that Hunter used had worked in 14 of the previous 15 years, with only modest losses in the single losing year, he had no basis to believe that this strategy would work this particular time. In short, the only valid claim Hunter could make is that he observed a persistent pattern in gas prices. He made no claim as to why this this pattern existed, nor any claim to the underlying cause and effect.

Although the natural gas market does exhibit certain predictable patterns over time —  namely, that summer demand is light and gas prices tend to fall, while winter demand is heavy and prices tend to rise — these patterns can easily be disrupted by shocks to the system, changes in weather patterns, economic growth, recessions, and so on. Hunter’s investment was based on the assumption that the historical pattern in natural gas prices would continue. It was simply a correlation trade. In fact, in September of 2006, the natural gas market did something it hadn’t done before. As natural gas inventories rose and the threat of another harsh hurricane season receded (2005 was a particularly harsh year for hurricanes), natural gas prices dropped. And winter-month contracts dropped much faster than summer months. Hunter’s strategy was wrong.

One of the overarching lessons here is that correlation is not causation.  As such, trades based on observed correlations must be diversified enough for the law of averages to work.  This means that correlation trades are an acceptable form of investing only insofar as the investor concedes that he or she knows little (or nothing) about why the patterns might persist, revert to the mean, etc.  Consequently, the investor in correlation trades must use small positions sizes and diversify risk across a large number of risk exposures. In contrast, trades based on understanding of cause and effect or an attractive upside-to-downside relationship can be undertaken with greater confidence. Though such trades still must be diversified to reflect the possibility of error in facts or judgement. In all cases, the investor must ensure that positions fit within the portfolio’s stated mandate, the viability of the firm is not jeopardized by the failure of a given trade, and the standards of prudence and fiduciary duty are met. In short, Amaranth “bet the farm” on correlation trades and hence failed on all these counts.

In making the bet, Hunter fell into the trap of status quo bias — that is, expecting past market behavior to persist in the future. Perhaps the large gains that Amaranth achieved in natural gas contracts the previous year led to a blinding greed trying to expand that success. Hunter failed to appreciate the difference between correlation and causation with respect to natural gas prices. Having found a historical anomaly, Hunter didn’t have an actionable item as a singular investment without understanding why the phenomenon might continue. Only by establishing causation could Amaranth make an actionable investment decision with a sound basis.

Alternatively, if these investments are viewed as part of a broad trading strategy to exploit anomalies (such as price patterns in various natural gas contracts), the strategy still failed, but for different reasons. In the case of trading on anomalies, traders must openly accept that they do not know why an anomaly exists, only that it does. In the absence of such knowledge, the trader/investor can only speculate as to whether or not the anomaly will continue. Therefore, a prudent investor/trader diversifies trades over a large pool of anomalies (ideally, among asset classes, geographical areas, and time). Speculating on such anomalies is an acceptable form of investment, but one’s position sizes must reflect ignorance about the reasons for the anomalies and therefore should remain a small percentage of the portfolio. Investors can find safety of principal only by exploiting large numbers of anomalies so as to diversify the risk. In this case, Hunter and Amaranth fund managers bet everything on a single theme. They failed to diversify appropriately and concentrated far too much risk in a single theme. With more than 50% of the portfolio invested in this particular trade, it was clearly overstated.

Although the calendar spread that Hunter used could theoretically support positions based on historical probabilities around natural gas prices, such a strategy is more likely to be successful if it meets certain conditions. A manager must acknowledge that he or she has imperfect insight into the future and must adequately assess whether the historical probabilities and payoffs are favorable for a particular strategy. The position should fit within the context of a given portfolio’s mandate, and the trade must be treated roughly the same as any other trade so that the law of averages has a chance to work. If it had worked, Hunter might now be famous for the amount of money he made on this call. Having bet so heavily, however, he virtually ensured a binary outcome without any middle ground. A sound trading strategy encompasses positions that probabilistically achieve both success and failure. In other words, an investor/trader must move away from focusing on a single expected outcome and begin thinking through possible outcomes or scenarios.

To compound matters, not only did Amaranth have a poor basis for establishing the positions that it did, the firm also ensured that it could not exit the positions in a timely way. By owning very large portions of specific natural gas contracts (in some categories, Amaranth owned more than 50% of a given contract), Amaranth in essence “became” the market for these contracts. What such a position meant in practice is that if the trades went wrong for any reason, Amaranth could not unwind its positions. Liquidity is required to exit any position, but it is acutely important during periods of stress — when not only do prices of securities perform poorly but also trading liquidity of the security deteriorates sharply, thereby making the contracts impossible to trade. Considering that Amaranth owned more than 50% of these troubled contracts, once Hunter’s position went south, nobody was willing to take the other side of these trades because they feared incurring the same liquidity problems. So, liquidity dried up and Amaranth could not exit at any price. Recognizing Amaranth’s distress, other hedge funds took the opposite sides of these trades, exacerbating the situation. Liquidity must be considered when evaluating risks related to exit strategies in times of stress (or as a potential opportunity should the investor be able to live with periods of stress if liquidity is mispriced).

Amaranth Advisors could have avoided all this grief by performing basic scenario planning to examine what would happen following various changes in underlying supply and demand for natural gas under mild, normal and severe weather scenarios. At the very least, the firm should have carried out what-if scenario analysis for adverse changes in market prices.

Amaranth and Hunter might have had the intent to manipulate prices in the natural gas markets (as regulators subsequently claimed), but we have not seen direct evidence to support this claim. Perhaps this crisis could have been avoided for Amaranth by not hiring Hunter in the first place. Human resource departments play an important role in understanding the nature of the people they hire. Of course, hiring Hunter may have been simply part of the firm’s desired trading strategy.

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  • 2000: Nicholas Maounis founds Amaranth Advisors, LLC. Amaranth’s flagship fund, the Amaranth LLC Fund, is established as a multistrategy fund that can invest in virtually any market.
  • December 2003: Deutsche Bank’s natural gas desk, headed by Brian Hunter, loses $51 million in a week and claims the loss is the result of an unforeseeable development in the market. Partially as a result of losing this trade, Hunter’s and Deutsche Bank’s relationship deteriorated and Hunter is removed from Deutsche’s trading team. Hunter is soon hired by Amaranth.
  • April 2005: Hunter, who joined Amaranth in early 2004, is named co-head of the energy desk and given control over his own trades. The firm increases its emphasis on energy trades.
  • Fall 2005: Hunter takes a bullish position on natural gas prices, and when the 2005 hurricane season interrupts natural gas production, causing prices to increase, Amaranth realizes large profits.

Central Events

  • August 2006: Amaranth reaches $9.2 billion in assets under management (AUM). Given his success in 2005, Hunter invests approximately $5.7 billion in a highly leveraged bet on the spreads between natural gas futures contracts for 2007 and 2008 (a calendar spread that was long winter-month contracts and short non-winter-month contracts).
  • Early to mid-September 2006: The 2006 hurricane season proves to be milder than anticipated, and natural gas production is largely uninterrupted, causing gas prices to plummet. Forecasts for a mild winter also send futures prices down. The spread between the March and April 2007 natural gas contracts narrows by more than 68%, rather than widening Hunter’s position predicted.
  • 14 September 2006: The portfolio loses $560 million in one day. As news of its troubles spreads through the market, Amaranth’s brokers make margin calls on its energy trades and liquidity in natural gas contracts dries up. Firm assets are down 50% in just two weeks.
  • 15 September 2006: The massive margin calls push principals at Amaranth to seek third parties to purchase its energy portfolio.
  • 20 September 2006: Unable to produce individual bids to buy out its natural gas exposures, Amaranth is forced to accept a single (low) bid on offer to preserve liquidity, meet margin calls, and avoid losing additional investor funds. The energy portfolio is sold to JP Morgan and Citadel LLC at steep discounts.
  • 21 September 2006: The natural gas market stabilizes, leaving Amaranth with more than $6 billion in losses (two-thirds of AUM).
  • 1 October 2006: Amaranth Advisors, LLC, begins to liquidate its assets.


  • 25 July 2007: The Commodity Futures Trading Commission (CFTC) and Federal Energy Regulatory Commission (FERC) charge Amaranth with, respectively, attempting to manipulate the prices of natural gas futures and market manipulation.
  • November 2007: Amaranth sues JP Morgan for interfering with its efforts to secure a better settlement deal with other parties during the collapse of its portfolio. Amaranth claims that the interference resulted in greater losses than were necessary. This lawsuit is later dismissed.
  • 22 January 2010: The FERC judge rules that trader Brian Hunter violated FERC’s Anti-Manipulation Rule.
  • April 2011: The FERC judge fines Hunter $30 million. Hunter appeals, and shortly thereafter, because the US Court of Appeals for the District of Columbia Circuit agrees that FERC did not have jurisdiction over the futures markets where Hunter was trading, he wins.
  • 15 September 2011: Hunter is listed among the Wall Street Journal’sRogue Traders through History.
  • September 2014: Hunter reaches a settlement with the CFTC in which he agrees to a $750,000 fine and restrictions on future trading including a prohibition on trading in daily closing periods for all CFTC-related natural gas products.

Investment Principles

Principle #1

Correlation is not causation. Prudent investing requires investors to treat correlation and causation differently.

Principle #2

Past market behavior does not equal future market behavior.

Principle #3

Adverse changes in liquidity can more than offset the perceived merits of an investment.

Principle #4

Scenario analysis and risk planning are needed to prepare an investor for an event that has not happened previously.

Principle #5

Risk management can take place at the human resource level of an organization.

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Anderson, Jenny. 2006. “Betting on the Weather and Taking an Ice-Cold Bath.New York Times (29 September).

Burton, Catherine, and Jenny Strasburg. 2006. “Amaranth’s $6.6 Billion Slide Began with Trader’s Bid to Quit.Bloomberg (6 December).

Chincarini, Ludwig B. 2007.”The Amaranth Debacle: A Failure of Risk Measures or a Failure of Risk Management?” The Journal of Alternative Investments (Winter 2007):91–104.

Chincarini, Ludwig B. “A Case Study on Risk Management: Lessons from the Collapse of Amaranth Advisors LLC.

Davis, Ann. 2006. “How Giant Bets on Natural Gas Sank Brash Hedge-Fund Trader.” Wall Street Journal (19 September).

Excessive Speculation in the Natural Gas Market.” 2007. Staff Report of the Permanent Subcommittee on Investigations, Committee on Homeland Security and Government Affairs, United States Senate (25 June).

Federal Energy Regulatory Commission. 2010. “Summary of FERC Ruling against Brian Hunter, Head Trader at Amaranth Advisors” (22 January).

Goodman, Leah McGrath. 2014. “The ‘Rogue Trader’ Who Got Away with It.Newsweek (17 September).

Maounis, Nick. 2006. “Investor Conference Call.” Amaranth Group, Inc. (22 September).

McCall, Matthew. 2006. “Losing the Amaranth Gamble.Investopedia (14 December).

Till, Hillary. 2007. “The Amaranth Collapse: What Happened and What Have We Learned Thus Far?” Working paper, EDHEC Risk and Asset Management Research Centre (August).

Zuckerman, Gregory. 2006. “How the Wreck from Amaranth Was Contained.” Wall Street Journal (5 October).

Additional Reading

Dreyfuss, Barbara T. 2013. Hedge Hogs: The Cowboy Traders behind Wall Street’s Largest Hedge Fund Disaster. New York: Random House.

Mallaby, Sebastian. 2011. More Money than God: Hedge Funds and the Making of a New Elite. London: Penguin Books.

Sklar, Ryan. 2009. “Hedges or Thickets: Protecting Investors from Hedge Fund Managers’ Conflicts of Interest.” Fordham Law Review, vol. 77, no. 6 (May):3251–3323.