With the industry is still awash in talk surrounding the Bank of Montreal's (BMO) recent natural gas trading losses of C$350-450 million (US$313.70-403.33 million), the aftershocks and tremors continue to be felt by others in the industry (see related story), including Valhalla, NY-based brokerage Optionable Inc., which reportedly has been linked to the bank. Some market watchers in their analysis of the event have gone as far as calling the natural gas market a "Catch-22," where you get in just as much trouble by hedging as not hedging.

The Financial Post said Optionable, which provides natural gas and other energy derivatives trading and brokerage services to brokerage firms, financial institutions, energy traders and hedge funds nationwide, makes a quarter of its revenue working with BMO's energy trading desk. The article added that the trades at the center of the BMO losses were conducted in New York, mostly on the New York Mercantile Exchange (Nymex) and the over-the-counter markets.

Following Toronto-based BMO's announcement Friday on losses due to wrong-way trades in natural gas, specifically out-of-the-money options (see Daily GPI, April 30), Optionable's stock plunged 20% from trading just above $7 to just below $5.50 before closing at $5.56 for the week. On Monday, Optionable's shares held their ground and were trading at $5.65 in late afternoon. Calls to Optionable's New York offices for comment were not returned as of press time.

"Unfortunately it would appear to be a case of guilt by association," said Tim Evans, an analyst with Citigroup in New York. "If the reports are true, then this is another example of the difficulty of having that type of exposure to one particular trading partner or source. Back in the days when Enron had their problems, part of the collateral damage from that shakeout was that everyone who traded on EnronOnline all had Enron as the counterparty to their trades. The market was overexposed to Enron as a trading partner, and we all know what happened next.

"Natural gas is a messy market that really doesn't offer any magic bullets when it comes to risk management," he added. "On the one hand, all of the volatility suggests that we ought to be running away from this market and not touching the futures or the options. However, the other hand says that same volatility makes it important to remain hedged by laying off our price risk into the market where appropriate, rather than letting it sit on the books. It really is a 'Catch-22' kind of a market. You're hurt if you don't put a position on, and you can be hurt even if you do. This is the kind of a marketplace where you can have an absolutely legitimate hedge on the books and still get hit for a substantial margin call that might force you to cough up your hedge position at just the wrong time."

Evans added that while he expects these hard luck stories to continue, he doesn't believe they will occur more frequently. "The money that changes hands and the risk that is out there is substantial. It would not surprise me if we have a relatively steady diet of stories like the Bank of Montreal," he said. "While I don't think it is going to be every day or every week, I think every couple of months the market will shift and we will find out who has problems. The market will shake the trees and we will see what falls out. One would hope that with greater experience, traders would become a little more cautious in their approach to the market in terms of trading size.

"This market can handle a lot larger trading volume than any one player ought to be committing to this market. It's one thing if the market can take it and it's another question entirely as to whether a big trading position is a good idea. I think it demonstrates some of the limitations of our methodology in trying to anticipate the exposures in the market. As an example, value-at-risk is a popular concept to try to measure just how much exposure someone has to the market, but it's not necessarily the bottom line. It is hard to fully define the actual price risk."

Evans added that there is also plain "luck" involved. "Win or lose, there were people who were on the winning side of Amaranth's trades, but the differences between being on the winning side or the losing side of those trades may have been simply a function of last year's hurricane season. If we had a storm here or there in the right part of the world, the tables might have been turned."

Last September, the Amaranth hedge fund collapsed following more than $6 billion in losses from wrong-way bets in the natural gas futures arena (see Daily GPI, Sept. 19, 2006; Sept. 27, 2006).

Looking at the bright side, Evans noted that BMO's losses were not crippling. "Unlike Amaranth, we are not talking about whether the Bank of Montreal can financially survive its losses," he said. "The loss is not of the scale to sink the bank, but it is enough to make management question their participation in the market. The loss was also large enough for shareholders to question whether energy trading is a business the bank should be in."

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