Updated from 2:05 p.m.

Amaranth, a big hedge fund, suffered huge losses last week on bad bets on natural gas trading. Observers said the revelation may explain some of the recent volatility in energy markets.

"We anticipate our year-to-date losses might be in excess of 35% as we near completion of the disposition of our natural gas exposure," the hedge fund said in a letter to investors obtained by TheStreet.com. The letter is signed by the hedge fund's founder, Nicholas Maounis.

A person familiar with Amaranth says the fund was up a little more than 20% for the year as recently as mid-August.

Using that figure, a back-of-an-envelope calculation means Amaranth at one point was up $1.5 billion for the year. But in recent weeks it may have lost as much as $4 billion. The fund, assuming it is down 35% for the year, now has about $5 billion in assets under management.

A person familiar with Amaranth says the fund lost about 60% of its value in a single week because of the bad natural gas bets. The losses were magnified by the fact that Amaranth's bets were leveraged, using borrowed money. This source says the natural gas trade was levered at a ratio of 5-to-1.

A trader with another hedge fund says the news of the big loss at Amaranth may explain some unusual trading in certain stocks last week. The trader speculated that Amaranth may have been liquidating positions in some of its equity holdings to satifisy the margin calls from its prime broker. Amaranth wouldn't comment beyond its letter to investors.

One commodities trading expert says the big trading loss at Amaranth shows what can happen when natural gas trades are conducted through the so-called over-the-counter marker rather than a monitored exchange such as the New York Mercantile Exchange.

Michael Greenberger, a professor at the University of Maryland Law School and former director of the division of trading and markets at the Commodity Futures Trading Commission, says that if the trades conducted by Amaranth had gone through the Nymex, regulators probably would have stepped in and their questioned the activity. Greenberg says the speculation is that Amaranth may have conducted most of its trading away from the Nymex in a bid to "corner" the long contract on natural gas futures.

"If that's the case, it amounts to manipulating the market," says Greenberger. "It has nothing to do with supply and demand. It's playing games in the opaque markets."

Based in Greenwich, Conn., Amaranth employs more than 360 people, including 115 traders. The fund's Web site tabs its assets at $7.5 billion, and the firm has offices in Houston, Toronto, London and Singapore. Sources say assets under management may have been more than $9 billion going into September.

"We have met every margin call to date," the letter continues. "We are in discussions with our prime brokers and other counterparties and are working to protect our investors while meeting the obligations of our creditors."

The hedge fund reported having $2.3 billion invested in U.S. stocks as of the end of June. Several of Amaranth's big investments were Humana ( HUM), Goldcorp ( GG) and Sprint ( S).

A broker gives a margin call when an investor or trader does not have adequate collateral to support the amount of money it has borrowed.

Even if Amaranth has been able to satisfy all of the margin calls, the big loss at the fund could have ramifications for others on Wall Street, especially institutional investors who bet on hedge funds. Some of the Wall Street firms with so-called hedge fund fund-of-funds that reported having big stakes in Amaranth include Morgan Stanley ( MS) and Credit Suisse ( CSR).

Amaranth is a six-year-old multistrategy fund that specializes in energy trading, merger arbitrage, convertible bond trading and regular long/short trading.

Brian Hunter is the head of energy trading at Amaranth. The fund employs about 21 energy traders. The hedge fund gets its name from the Greek word amarantos, which means unfading.

Even before Amaranth released a copy of its investor letter Monday, Wall Street traders were buzzing that the hedge fund had lost a ton of money on natural gas trades.

The energy markets have been particularly volatile this year. Many funds have made a great deal of money riding the spike in oil prices to new heights this summer. But a number have been caught on the wrong side of trades, especially since energy prices have turned on a dime.

Most notably, MotherRock, a two-year-old fund that once had nearly $450 million in assets, shut its doors in late July after losing nearly half of its value. Led by former New York Mercantile Exchange President J. Robert "Bo" Collins, MotherRock also bet wrong on natural gas prices.

But unlike Amaranth, MotherRock got caught betting that natural gas would fall at a time that the commodity was soaring to new heights. The irony is that if MotherRock could have held on for another few months, it might have recovered much of its losses.

Last week, MotherRock told investors it was unlikely they would get back any money of the fund.