The oil industry refers to the differential between the price of Crude Oil and Petroleum products extracted from it as the “Crack Spread”. A refinery “cracks” Crude Oil into Gasoline or Diesel and the spread between what they can sell the products at and their cost of crude (minus also refining costs) is their profit margin A table of the Crack Spread components was displayed. They include WTI Crude Oil (/CL), ULSD Heating Oil (/HO) and RBOB Gasoline (/RB).
There are two types of Crack Spreads. The diversified spread might be 2 /RB + 1 /HO - 3 /CL. There are also other variations with more complex ratios. The problem is that there is no margin relief for the diversified spreads and they can tie up quite a bit of capital. We’ll look at one of the simple spreads /HO- /CL instead. A graph showed that the /HO has seen a much steeper drop in price compared to /CL. Pete explained some of the fundamental reasons behind the moves in Diesel and Crude, including weather and the demand for the transportation of goods. This may lead traders to think that /HO will gain on /CL.
Pete related how to adjust the Futures contracts to account for the differing physical sizes and terms. He also noted that the differences allows us to underhedge the /HO buy selling a call in /CL, thus adding a Theta component. A table listing buying /HO and selling a call option in /CL displayed Pete’s trade idea.
For more on the Crack Spread see:
Closing The Gap - Futures Edition: from February 13, 2015: “Trading The Crack Spread”
Closing The Gap - Futures Edition: from August 14, 2015: “The Crack Spread”
Closing The Gap - Futures Edition: from December 18, 2015: “Crack Spread”
Watch this segment of Closing The Gap - Futures Edition with with Tom Sosnoff, Tony Battista and Pete Mulmat for a look into the “Crack Spread” and possible trade idea you may want to try.
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