“If it be now, tis not to come, if it be not to come, it will be now; if it be not now, yet it will come. The readiness is all.” – Shakespeare: Hamlet Act 5, Scene 2
UPDATE HERE (3/26/2020)
Last Friday, March 20, CNBC was first to report that “one of the CME’s direct clearing firms was unable to meet its capital requirements. The move forced the exchange to step in and invoke its emergency protocols to auction off the portfolios. Ronin Capital, based in Chicago, was confirmed to be the firm in question, according to sources. Additional sources said Ronin’s problems stemmed from positions in futures tied to the CBOE Volatility Index (VIX).”
In concert with Alphacution’s recent feed post, “Marketquake: The Volatility of Volatility,” on unprecedented volatility levels that surpass that of the 2008-2009 Global Financial Crisis (GFC) period, I wanted to assemble whatever we could on Ronin.
A story not well known outside of Chicago prop trading circles, John S. Stafford, Jr. – the founder of what eventually became known as Ronin Capital in late 2001 – rose to prominence on the floor of the Chicago Board Options Exchange (CBOE) in the 80’s and early 90’s. Like those few of his vintage, Stafford eventually transitioned off the floor; becoming one of the foremost backers of upstart CBOE floor traders, much in the same vein as the likes of Lee Tenzer (LETCO; the first to hire future DRW founder, Don Wilson) and Steve Fossett (Marathon Securities / Lakota Trading; and the adventurer to complete the world’s first solo circumnavigation of the Earth in a hot air balloon). In those days, I might occasionally run into Mr. Stafford at a neighboring stair climbing machine at the old LaSalle Club…
A maniacal sensitivity to risk management was the key to the success of guys like Stafford, particularly as they transitioned to managing multiple traders and multiple books. Furthermore, this factor never changed as the floor business gradually gave way to automated and high-turnover trading strategies spread across trading venues, regions and asset classes; and Stafford Trading eventually seeded Ronin Capital – to be operated by his son, John Stafford III – with its registrations, technical infrastructure, capital and deep institutional acumen.
It is this culture of risk management upon which Ronin has thrived for so long that makes its sudden demise so strange and surprising…
Now, by hedge fund standards, Ronin might have been considered among the largest in the world. The most recent regulatory data (from year-end 2018) showcased total assets of $21.2 billion, which was nearly 9x and over 40x that of the same reading for the core units of the more famous Chicago prop firms, DRW and Jump Trading, respectively, for the same period (see below).
This base translated into market exposures ranging roughly between $10 and $20 billion since the GFC, as measured by gross securities fair values (or, long values plus short values across asset classes)…
And, resulting in member’s equity – a measure of retained earnings – that grew over the 18-year period to $415.6 million, as of year-end 2018 (see below).
When we look a little more closely at the portfolio composition, we see that it is mostly made up of US government securities, followed by cash equities, equity options, and options on futures (OOFs) – among a few other categories like corporate and municipal bonds (see below).
And, when we further break the data down into net securities value by product class, we can see – generally speaking – that the equities books tended to be managed more tightly from a simple dollar neutrality perspective than the US government securities (i.e. – fixed income) book and the OOF books (at least a portion of which we are assuming are options on fixed income futures).
Now, all of this setup may end up being little more than a novelty. Given how quiet prop firms tend to be, we may never hear anything more about what happened here. And, the explanation that Ronin was brought down by some VIX-related futures position gone haywire may stand as the only explanation ever semi-officially offered by “additional sources.”
But, here’s another thought, just for grins and giggles: I’m wondering how a pedigreed firm with this kind of balance sheet – ostensibly full of “government securities” with an average net long value of $7.5 billion for the four years between 2015 and 2018 – gets taken down by positions in futures tied to the VIX. It doesn’t make much sense given the history, capabilities, and global reach of Ronin…
Sure, the overall book and underlying strategies may have shifted since 2018. Lots of things could have changed since then. Ronin could have been in existential decline throughout 2019 and early 2020. (Certainly, the fact that expected regulatory filings for 2019 – typically made by March 1 of the subsequent year – had not been made, is a small potential clue of problems.) And, lots of “fat finger” type mistakes can still happen to trigger a blow up. We just don’t know (from the available data). But, with so many ways to hedge and trade out of stuck positions given access to liquidity all over the world, it would stand to reason that there’s more to this story…
Chances are this is actually about a large negative gamma / positive theta position in options.
Option market makers – and prop firms that traffic regularly in options – are often net short options. This is true because customer flow is typically looking to be long options and the professionals take the other side of that flow – and then manage the risk by trading in the underlyings and layering deltas as new flows occur. This is basically true across asset classes. Meaning: Ronin – and others – are, for example, regularly short VIX options at the CBOE against equity futures at the CME as well as being short Treasury OOFs against holdings in US bonds.
With negative gamma positions – usually in the form of short out-of-the-money “wing” positions – large moves in any underlying security cause these options positions to balloon, sometimes in existentially uncomfortable ways. So, the question is: What is more likely? The legendary Stafford lineage of Ronin Capital blowing up over VIX options or possibly blowing up over fixed income OOFs?
Curious about your thoughts (sent to email@example.com) and happy to make amendments or correct any errors above.
UPDATE HERE (3/26/2020)
Until next time, stay safe out there…