The Crack Spread is a trade that is comprised of the refined products that make up a barrel of oil. Theoretically when all of the products are combined, the price should be similar to a barrel of oil. However, this may not always be the case.

Today, Tom Sosnoff and Tony Battista are joined by Pete Mulmat of the CME Group. Pete explains how a barrel of oil is broken down and how a crack spread should be structured. After all is said and done, Tom puts on the trade!

Tony: Thomas is back, my friend. Closing the Gap, Futures Edition.
Tom: Hola, Pete. How are you?
Pete: I'm very good. How are you guys?
Tom: We're great.
Tony: Are you allowed to use, "Hola, Pete," with Pete?
Tom: I think so.
Tony: Okay.
Tom: Casey's not here today.
Tony: Okay.
Tom: Yes, so I can only use it once a day. I'm only allowed one hola per day, and you just got my hola.
Pete: I got the hola!
Tom: You should feel honored.
Pete: It's a huge day.
Tony: I've known him for 30 years. I didn't get one hola in my whole life.
Tom: No, you you don't get holas.
How are you?
Pete: I'm great. How are you?
Tom: We're good. We're good. It's cold out today, so it's a perfect day to have a heating oil discussion.
Pete: It is. Yes, and it's something that's moving, too, and the crack spread is really foundational. Even if you're not constructing the trades we're talking about, having an idea of this relationship of how the outputs from crude drive the underlying is important. It will make you trade, hopefully give you a better set of tools to trade crude with.
Tom: Do you know what? I think today's trader, like, all the young people that trade today, I don't think anybody knows what heating oil is.
Tony: Yeah, no.
Tom: Like, I grew up in my house, which was …
Tony: Estate.
Tom: I'm sorry. I'm my palatial estate, when I was allowed to enter the lower quarters, where the …
Tony: Servants.
Tom: servants were, we would have heating oil delivered to our house a couple times a … Did you grow up with heat … ?
Tony: Yeah.
Tom: Did you grow up with heating oil?
Pete: No. I was always a natural gas guy, because I was from here.
Tom: Natural gas. Yeah.
Tony: It's an east coast thing.
Tom: Yeah, it's an east coast thing. I never heard him say … We used to get these trucks with these, like, what did they have, like, 300 foot hoses, you know? They'd carry them over. They'd be over the hedges, and you know how they go through the … "Don't put the hose through the flowers," my mom would yell at the guy, you know?
Pete: Right.
Tony: It was a big black hose, too, yeah.
Tom: Yeah, and then it would be like, it would circle around, down the stairs, up the stairs, through the house, down the basement. I mean, it was … When you think of what used to go on, just to, you know, load up on heating oil. "It's better than wood," my dad used to go. "It's better than wood!" So I think people are like, "What the hell is heating oil?"
So anyway, that just, getting back. So today we're going to cover … What do they say? Unbundle a barrel of crude?
Pete: Yeah. That is a great analogy. We're going to break down, basically, what is crude? I mean, we all know and have traded, lot of us have traded crude. What is crude used for, and what are the byproducts from the cracking process, or refining process, and how those variables basically drive prices of not only the underlying, but the two refined products? so we're going to explore that.
Tom: The most important distinction of this discussion today, when we first started out, is … The reason we do this is to have some reasonable understanding of what the products are that you trade. Like, the purpose of today's discussion is not to say, "Hey, the crack spread is ridiculously expensive. The crack spread's ridiculously cheap. Oil's cheap. Oil's expensive. Gas is cheap, or gas is expensive." The purpose of today is, hey, just know what you're trading, and see if that interests you, and if it interests you, hey, here's another product. Actually, here's three more products, and there's multiple ways to play this, including the exchange of futures and potential theta decay and everything else, because like this morning, I was trying to … I've already traded some crude oil calls, and what I'm trying to do, because of the high implied volatility in crude oil right now is sell some crude oil premium, non-directional premium in crude oil, because I have some long stocks that are …
Tony: Correlated.
Tom: correlated.
Pete: Sure, sure. Absolutely.
Tom: So I guess the point is, hey, the more we learn, and the more we understand, I think, the better we all become as traders, and I can tell you right now, Pete, I think the last time I did the crack spread was by peer pressure. A couple of guys that were, I think I'm going back like 20 years, and a few friends were like, "We're trading this spread. How many do you want?" You know, like that.
I'm like, "What is it?"
"That's the crack spread."
You don't want to seem like an idiot, you know, like, "Sure."
Tony: "Oh, sure."
Pete: "I'll take the allocation."
Tom: "Yeah, I'll do, 10? You know, whatever."
They're like, "Yeah, okay, you got 10, Johnny," you know, and that would be it, and I'm like, I didn't even know what I was trading. Just tell me when we're up money, right?
Pete: Right.
Tom: Okay, so the crack spread is the term used in the oil industry and futures trading for the differential between the price of crude oil and petroleum products extracted from it. That is, the profit margin that an oil refinery can expect to make by "cracking" crude oil, refining it into gasoline and/or diesel.
So explain what we have here. This is a … and you'll see it better on your home computer.
Pete: Right, and this is just a very simple example of what is cracking? Cracking is separating long-chain hydrocarbons into short-chain ones. Basically, it's taking crude oil and refining it into all these different distillates, whether it be something like gasoline, like heating oil, propane, butane, methane, and to do this, they heat the crude oil, and then these cracking towers basically, depending on how far the condensate rises, as it rises …
Tom: Separates it?
Pete: It separates, them. So this is just a visual to show you how, depending on where you are within that heating and cooling process, you get all these different distillates, and depending on how the refiner is running, they can maximize the output of any of these distillates depending on market supply and demand.
But remember, the one thing were talking about here is that we're trying to look at the biggest components of these, and out of every barrel of crude oil refined, 48 percent of it is turned into gasoline, 22 percent of it is turned into diesel fuel or home heating oil. So those are the two biggest components of the distillate process.
Tom: I've got it. Very interesting, and now they all trade as independent underlyings, correct?
Pete: They do.
Tom: Is there a trade … Does the spread itself trade?
Pete: The spread itself does trade. It trades, but I would imagine from my experience and what I've seen, it would be better … It's more productive to [lug 06:27] these spreads right now, so perhaps …
Tom: More productive as a [late 00:00] spread.
Pete: Yes.
Tom: So you're saying that the spread itself may be a little illiquid? Is that it?
Pete: At times.
Tom: Okay, at times. Now, have you traded these products yourself with your …
Pete: I have.
Tom: You have.
Pete: Yeah, it's a fantastic trade, and again, it gives you another insight, especially around areas when you … As we saw, crude has been the perfect example in the last three months. I mean, we've all thought about, you know, "Boy, 60s look good, 50s look good, and 44s look really good." That's been a struggle. Oft times, when we're looking for a bottom, we're looking for some ways to determine that, and one of the ways you can look at how the supply and demand of this particular underlying, crude, may be driven, it's the relationship to these two outputs, because these are the critical components of, is a refinery buying more crude? Is it buying less crude? What is that demand side, and it is often driven by the supply and demand and the prices of these two underlyings.
Tom: So what we put up here as the contract itself, which is CL is crude oil, HO is heating oil, and RBOB, which I just, I didn't actually know what the RBOB meant, but I …
Pete: I get this … This is tough, because I still get this wrong. Reformulated blendstock of oxygenated blending.
Tom: We're testing you this afternoon on that fact. If you can get that …
Tony: That's what Bob the Trader is named after. Everybody knows what RBOB is.
Tom: Yes. Bob the Trader has now been named after … What did we say again? I've already forgot it. Reformulated … But very interesting. So then you have the barrels, the gallons. I didn't actually know any of this stuff, the underlying quotes, the tick size. The tick size is is pretty much … Well, actually, it's not, because the tick value … Okay, I've got it now.
Pete: Yeah, a little bit different, here.
Tom: Yeah, a little bit different.
Pete: What are the two … The two fundamental takeaways are that crude is quoted, as we're all comfortable, in dollars per barrel. What we used to call heating oil, now it's referred to as ULSD, that stands for ultra-low-sulfur diesel. It's a little lighter blend. It's a more EPA compliant blend, so this is the benchmark now for what you and I had traded as a heating oil contract. It's ultra-low-sulfur diesel. Again, the RBOB, both those are quoted in gallons, dollars per gallon, so we have to convert that, and we'll walk through that, of how do we look at these three components, these three products, and gain a common sense of pricing out of them?
Tom: Very interesting. That really is, and here the one … we just added the 1 month correlation matrix of daily returns, so now we can see what the relationship is, so obviously you can see how tight this is: 1 to .85 to .83, so we would call the difference between crude, gasoline, and heating oil, we would call that .15 or .17 basis points, to be what we'd call basis spread.
Pete: Right.
Tom: So I guess when you're breaking this apart, if you want to know how much risk reduction you've done, it's about 85 percent, okay?
Tony: This is what we feel most spreads on futures are.
Tom: The inverse of the correlation, of the correlated relationship, is essentially what we call kind of the risk. One of the reasons you trade these products against each other is because it extends duration and reduces risk, and so how much is the risk reduced? Well, it's reduced by the amount of the correlation, which is .85, so there's about 15 to 17 percent of the risk left in the trade, and that's why it's less risk, but why it's interesting. At least you know where that is. So, as opposed to doing … So in other words, if you bought or sold crude, your risk is 100 percent, and if you bought and sold crude …
Tony: 100 percent of the move.
Tom: Yeah, 100 percent of the move. If you bought or sold crude versus gasoline or heating oil, it's …
Tony: The relationship should move 85 percent less.
Tom: 85 or 83 percent of the risk remains.
Pete: Right.
Tom: Okay. Cool. Here's the simple 1 to 1 crack spread. This is most common, so it represents the refinery profit margin between the different refined products, but so let's understand this.
Pete: Right, and this is the most simple version of it, and it's using either an RBOB gasoline contract, or a ultra-low-sulfur diesel contract, and taking one, basically being short one, against a long crude contract, or short a crude against a long gasoline contract. So this is basically comparing one of the outputs from the refinery process against the input.
Tom: So are you saying that because based on the tick sizes of 420 to 10 dollars, does the RBOB and the heating oil, or the diesel, do they move 2 to 1, pretty much?
Pete: No.
Tom: Okay, okay.
Pete: No, not necessarily. In terms of … and we were just working on that, too. In terms of the net dollar move of them, part of that is dynamic, because if you have crude stay steady, and you get a move in the crack spread on the refined product side at 420 a tick, you get a different change, so a move in the crack spread, and we'll show the chart next, between 20 and 21, isn't a defined number.
Tom: I've got it. So I'm just looking at RBOB right now.
Pete: Right.
Tom: And it's up .0237, so that would be 237 times .42, right?
Pete: Right.
Tom: Okay, and if I look at the crude oil, it's up 149, so the difference, so that is very close to almost a 2 to 1 move.
Pete: Right.
Tom: Because if you took 140, 150 times 10, and let's just say on a 1, that's 1500 bucks, and if you 230 times 4.2 that's going to be … It's going to be pretty close, right? It's going to be like …
Tony: 230 times by what? 4.2?
Tom: 4.2. What is that?
Tony: 966
Tom: 966. So what you're saying, you say, if we had that spread on, 'cause crude oil's had a big move today.
Pete: Right.
Tom: If we had that spread on 1 to 1, like long one crude oil, short one RBOB, it'd be about 500 dollars toward crude oil today, is that correct?
Pete: Right. Right. Yes.
Tom: Okay.
Tony: You keep saying RBOB. On the TOS platform, it's forward slash RB, just so if everybody's looking at the symbol.
Tom: Yes, and heating oil is HO
Tony: Forward slash HO.
Tom: Forward slash HO, and that's up 433, so that would 433 times 4.2, right?
Pete: Right.
Tom: So what's that, Tony? Just do that real quick.
Tony: What do you need? Say it again?
Tom: 433 times .42. This is really good, because this would give people …
Tony: 181 and change.
Tom: Right, so that's 1800 dollars.
Pete: Right.
Tom: So if you had it versus … So these things move.
Pete: They absolutely do, and crude's implied volatility now is now about 51 percent now. RBOB's is close to 57. The ultra-low-sulfur diesel is about 52 and a half, and RBOB, almost always, historically, is the most volatile of the three components.
Tom: I got it. So heating oil today has moved 1800 dollars. Crude oil has moved 1500, at least on one lot. Crude oil's moved 1500 dollars, and gasoline has moved about 1000 dollars, so …
Pete: Right.
Tony: Since you're talking about the relationship, and it's going to get further on, you're talking about 3 to 2 to 1 ratio? Is that what you're [crosstalk 00:00:00]?
Tom: No, not yet.
Pete: Not yet.
Tom: We're just talking about 1 to 1. 1 to 1 to 1. So I'm just pointing out that it's volatile. So let's see. What do we have here? So this is price quotations and tick values.
Pete: Right.
Tom: Help us.
Pete: Sure. So again, usually the crack spread is quoted as the refined products minus the crude price. That's the refiner's margin. In other words, what their going to …
Tom: Got it.
Pete: They want their refined products to be more than the input costs of refining them. Crude, as we know, is quoted in dollars per barrel. Now RBOB and ultra-low-sulfur diesel are quoted in dollars per gallon, so we need to convert this to a common way, so we can look at these as a spread. Now how do we convert it? Well, this is a given. There are 42 gallons in a barrel, so if we take the per gallon price of either of these components and multiply if by 42, we get an equivalent quantity/price …
Tom: That's where you get the 420. Got it.
Pete: for the refined products when comparing it to crude pricing.
Tom: Those sneaky little 42 gallons in a barrel.
Pete: They always … It always …
Tom: I asked you, Tony, how many gallons are in a barrel, and you couldn't tell me is was just 42.
Tony: Of course not.
Tom: I couldn't figure out how to get …
Pete: Those contract sizes always make sense, once you walk through. Yeah.
Tom: They couldn't just make it easier and make everything times .10, you know? Like, I know … I know there's another way to do this somewhere.
Tony: There's another way to do this somewhere.
Pete: I shouldn't have said anything, okay?
Tom: There's another way to do this somehow, where everything can have the same number, but we'll go with the 42 gallons in a barrel.
Pete: Very good.
Tom: When did they decide this, by the way? Was it, like, a bunch of guys sitting around a …
Tony: Some wildcat, or …
Tom: Yeah, was it like, who's …
Tony: "What are we going to do? 50 gallons?"
"Nah. 42."
Tom: "Nah. 42."
"Yeah, 42. 42 fits perfect in this barrel."
Tony: They'll think it's 50.
Pete: Well, the barrel is 42.
Tom: Yeah, got it.
Pete: So let's go ahead and jump ahead one more, if we can, Tom.
Tom: Sure.
Pete: Okay, so we know that this … So to get equivalent values, per barrel values, so we take our RBOB price, which is 1.5899, and then again, these guys, the team created these with me yesterday, so I may be off a little bit.
Tom: Yeah, sure.
Pete: We times it by 42 …
Tom: Gallons.
Pete: Gallons, and so that gives us a converted price of 66.74 per barrel. So if we look at the RBOB, it's basically selling at 66.74 per barrel, and the input, what I need to produce at, is a barrel of crude oil at 50.49. That shows us our refinery margin. That is our crack spread right there. It's trading at 16 dollars and 25 cents.
Tom: Oh. So that's what we were talking about when beef was sucking earlier, it's closer to 20, blah, blah, blah. That's …
Pete: Well, what beef is looking at is a different crack spread, and it's one we're going to dive into. It's called the diversified crack spread. We'll spend just a minute on this, because this is just one product against another, 1 for 1.
Tom: This is just 1 for 1, the RBOB against the crude oil.
Pete: Right, and you can also do heating oil, ULSD, against crude oil, too, and that is …
Tom: Okay. No, go back. That's the 42 times RB over the CL.
Pete: Right.
Tom: Just to give you that, what beef was looking at earlier. It's down a little bit more today. Yeah.
Tony: Mm-hmm (affirmative)
Tom: Cool. Okay, so that would …
Tony: Just give you a relationship of where it's been.
Tom: Yeah, okay. I've got it.
Pete: Right.
Tom: Perfect. So I'm starting to understand this now.
Pete: Okay, good.
Tom: Okay, what do we have here?
Pete: Here, just the two charts. On the right is [our bar 17:02] of gallons. Again, this goes back to before we had the correlation slide, this shows the correlation. They are correlated. The correlation is dynamic over time. One often will have a greater volatility to it and greater movement relative to the other.
Tom: This is the 83, 85 percent correlation?
Pete: This is … right. It's just another visual of that.
Tom: Got it, and this is when you convert RBOB to crude with equivalent pricing, so this is your 16.44, and now what you're showing us here … So if I looked at this right now, and I wanted to trade this …
Pete: Right.
Tom: If I wanted to, which to me means I want to … Let's make sure I have this right.
Pete: All right.
Tom: I would think that this means I would want to sell this. Is that what it means or not?
Tony: Well, that depends on if you think it's going lower.
Tom: I think it's going lower. Does that mean I'm buying it or selling it?
Pete: Okay, here … It's a great question. What we always do when we're trading crack spreads is the distillates, the refined products, the RBOB and ULSD, whatever we do with those, we're doing with the crack spread.
Tom: Right. Same as the way you do with futures …
Tony: Notes over bonds?
Tom: Same as you do with all futures spreads. It's always what you do with the first month.
Pete: Well, it's not the month here, though, right?
Tom: Sorry. You're right. You're right.
Pete: Two different products.
Tom: So it's what you do with the first product.
Pete: Well, so, it's the refined side of it.
Tom: Got it.
Pete: Just for this one, this one you got me on a little bit. It's very specific. It isn't uniform, but what … so the refined product, so if I'm going to use RBOB or gasoline, RBOB or heating oil, it's whatever I'm doing [without lagging 18:29]. If I'm selling RBOB to buy crude, I'm selling the crack spread.
Tom: Okay, so in this case, I would be selling RBOB and buying crude.
Pete: Yes.
Tom: Is this correct?
Pete: That's correct.
Tom: Selling RBOB and buying crude. Okay, so …
Tony: If you think this is going to go from …
Tom: If I think this 16 to 15 …
Pete: Right.
Tom: Okay, so hold on. So we're going to do … Hang on, because I don't want to mess this up. So I'm going to do my first … What would this spread be called?
Pete: This is a simple crack spread.
Tom: Simple crack spread, and I'm buying it, or selling it?
Pete: You are selling the spread, because you are selling the distilled product.
Tom: Because I'm selling the RBOB.
Pete: Right.
Tony: So you're selling RB, is that correct?
Pete: Yep. He's selling 1 RB and you're buying 1 CL.
Tom: And I can't tell you how much this pains me to buy a CL up here. Remember that. Just so you know, okay, this is [crosstalk 19:19].
Tony: He must really like you, Pete. I don't know.
Tom: I really like Pete, yes. So I'm going to do the spread, and the nice thing on TOS is I can do this …
Tony: So I have a question. You going to use the March future, which only has a few days left in CL?
Tom: There's 7 days left, right?
Tony: Mm-hmm (affirmative), and the R …
Tom: Yeah, I'm holding this spread for a couple of hours. I mean, this spread moves.
Tony: Okay. Okay.
Tom: Right?
Pete: Yes.
Tom: I mean, I'm just doing this because I think we have to practice what we preach.
Pete: Tell him to try RBL.
Tony: Okay, I got it. It just took a second.
Tom: I'm Phil.
Tony: Mm-hmm (affirmative)
Tom: So one of the cool things about TOS is that we … Now, I wish they would route this as a single spread with a single price.
Pete: Right.
Tom: But they don't, which is fine, so you have to route it as two simultaneous orders, and let me just say, for purposes of execution, facilitation of these trades, you don't mess with this stuff. Like, this is what we call, I use, "marketable limits".
Tony: Yes.
Tom: Which just means I'm not messing around for one tick and missing it, or doing whatever. I'm learning right now, so I bought …
Tony: You don't want to take a way the … You don't want to put back on the 85 percent risk that you're mitigating my doing the spread.
Tom: That's right, so I just bought the offer, sold the bid, but it literally was just one tick wide.
Pete: Right, and that liquidity sits there, and …
Tom: And I routed the orders simultaneously.
Tony: And that's what you did up there. You bought oil, and you sold RB.
Tom: That's right. I just did it so we can have that trade on for today.
Pete: Right. Okay.
Tom: Now let's go back to the slides, please. We got to move, here.
Tony: Well, Pete, you're like 100 percent on all these things, so [crosstalk 20:40] …
Tom: You had to be nimble. I'm still telling you right now …
Pete: [crosstalk 20:43] a loser if you don't get out.
Tom: If you didn't get out of copper the same day …
Pete: Ah!
Tony: Yes. Yes.
Pete: I got the copper axed. Copper Pete was my name.
Tom: But there was actually, if you've been just, if you were trading these, everything we talked about, there was an opportunity because of probability of touch, cyclicality, there's been an opportunity on everything, to … But I'm learning here, and I can't learn unless I do something.
Tony: Sure.
Pete: Right.
Tom: I have to do it to learn. Okay.
Pete: So this is what we …
Tom: This is what I just did.
Pete: Well, this is the opposite …
Tom: This is the opposite [crosstalk 21:11].
Pete: This is what a refiner would do.
Tom: I got it.
Pete: You know, because a refiner is naturally long on the crack spread.
Tom: Sure.
Pete: They would sell that.
Tom: I just did the opposite, so I am short this spread right now.
Pete: Right. Right.
Tom: And only because I'm a contrarian, and I do the opposite of whatever else we write on here, for whatever reason. I don't even know. So now this is the diversified crack spread. Help me here.
Pete: Right, now this is a diversified … So we talked a little bit, what are the two major components that come out of the refining process? Well, we know it's 50 percent, 48 percent gasoline, 22 percent diesel fuel, and the rest runs from everything from tar to methane, butane, and ethanol.
Tom: Got it.
Pete: So what we're doing here is taking the bulk of that products that come out of there, and creating a three-legged spread that more accurately reflects the profit margins for these products. So we're going to take, by doing this, we take 2 RBOB contracts, because we know that it produces twice as much per barrel of crude. We take a single ultra-low-sulfur diesel contract, and then we use 3 barrels of crude oil. So in other words, we create …
Tony: If you didn't like buying one crude oil, you're really going to have a hard time with three more.
Tom: Okay, so now I'm setting this up in my order entry bar, because again, you got to practice what you preach. If this show's going to be what we say it is, we have to do everything. So, Pete, what I'm doing right now, based on what you said, I'm selling 2 RBOBs, I'm buying 3 crude oils, I'm selling 1 heating oil.
Pete: That's correct.
Tom: That's my spread, right?
Tony: I have it up on the screen, yes.
Pete: That's is your spread.
Tom: That's my spread. I'm selling 2 RBOBs, I'm buying 3 crude oil, and selling one heating oil.
Pete: Right.
Tom: And I would be a seller of this spread.
Pete: Yes.
Tom: Okay.
Pete: Because whatever we do with the refined products, the distillates, we're doing with the spread.
Tom: Boom, boom, boom. Filled.
Pete: There you go.
Tom: Okay. We actually get the fills before you even hear the sounds.
Pete: You guys, you know …
Tom: That's what's the beautiful thing about …
Pete: It is.
Tom: Like, when somebody said, "Oh, my God. The pit trading is going away," the first thing we said is, "Thank you." Well, first of all, retail customers don't trade pit products.
Pete: Right.
Tom: It's been 15 years since … I don't think any retail customer has ever had a pit product fill, but what you can do electronically now, just the fact that we can do this in, what, 100 milliseconds, 3 different fills on 3 different products instantaneously, is amazing. I'm just grateful.
Pete: No. We're used to having to physically get up, walk out, pick up a phone. The democratization of the playing field has been tremendous. It's so empowering for everybody, with the slide of a mouse, to reach all these opportunities, find the opportunities that fit them.
Tom: Levels the playing field for the individual investor.
Pete: Yes, it does.
Tom: There is no advantage for the professional versus the retail with respect to just that execution. Zero.
Pete: Right. Right.
Tom: So okay. So now I have this spread on. So now I have on a diversified crack spread.
Pete: You do.
Tom: I'm 3 by 2 by 1, and I have on the, which I'm short,
Pete: Right.
Tom: and I also have on the short crack spread.
Pete: The short RBOB … The short gasoline crack spread.
Tom: Yes.
Pete: Right, and again …
Tom: And I thought crude oil was going down today, and I just …
Tony: Well, the short term low thing, yes.
Tom: I thought crude oil was going down today. I just bout 4 contracts, but I've also sold 4 contracts of other stuff.
Pete: Well, you've sold more than four contracts of other stuff.
Tom: Uh.
Pete: No, no, no. You sold 4 contracts of other stuff. Excuse me. You're right.
Tom: This is 1 to 1 to 1.
Pete: Right, right, right, right. So what this walks through really quick is the idea of this quoting convention. This crack spread, we saw the gasoline crude one at 16 dollars. This one trades at roughly, it's about 20, 20.35 right here, and we just walked though the math of, okay, we know we've got to uniformly come up with a way of quoting each of these, so we change the gallons to barrels, and then how do we come up with the number for this spread? We basically add the two outputs, the gasoline, the heating oil, subtract the input, which is the crude oil, and then we divide that by three. That's where we get our 20.35, which you will see on the TOS platform.
Tom: That's beautiful. I got it. So this is what I'm selling.
Pete: This is exactly what you're selling.
Tom: Good. Done. Sold. Sold back. Take a Phil.
Tony: Take a Phil.
Tom: I would sell that all day long. The good news is, while you were talking, Pete, the S&Ps have been dropping, so everybody's happy.
Pete: All right!
Tom: [inaudible 25:30] down on the day yet, though, but here's the 3 by 2 by 1 crack spread, and again, if we had more time, which we will on a later day with Pete, because we're going to expand this program, which we're really excited about, to try to get you on weekly, and we can talk more about this, because you can add in crude oil. Like, I used options this morning. We can add in crude oil options here, so it would just add a premium decay element to this whole trade. I am so excited.
So this is exactly what we've done. Now, what I just did required 33,000 dollars in capital, right?
Pete: Yes, and buying power reduction.
Tom: So that's an overnight requirement.
Pete: Yes.
Tom: Okay, so just so you know, it's not cheap to do. I just want to point that out, but again, this is all about foundational learning, and without foundational learning, you can't get to the next level of being able to do at any capacity. So I think it's just super important. What an unbelievable segment, and we're not with this. We're not done with this.
Pete: No. There's so many different ways to … There's even a 5, 3, 2 crack spread, if you're refining during the … seasonality comes into it.
Tom: 3, 2, 1 is okay for now. Okay, we're good.
Pete: We won't load you up too heavily on the …
Tony: [crosstalk 26:25] 85 percent less risk!
Tom: We'll start with 3, 2, 1, then we'll go [crosstalk 26:39].
Pete: That's good enough.
Tom: Pete, thank you so much. That was awesome.
Pete: Thank you, Tom. Tony, thank you so much.
Tony: We're going to take a 30-second break. We'll come back with the opening bell. You're listening to tastylive Live.