This video demonstrates how to set up a simple crack spread with Gasoline and Crude futures.What Is A Crack Spread?
The spread created in commodity markets by purchasing crude oil futures and offsetting the position by selling gasoline and heating oil futures.
The name of this strategy is derived from the fact that "cracking" oil (refining it) produces gasoline and heating oil. Therefore, oil refiners are able to generate residual income by entering into these transactions.
The crack spread represents the theoretical refining margin. If a crack spread is a positive number then the price of the refined products is higher than that of crude oil, the raw material, and the spread is profitable. If the spread is a negative number, the products are priced at less than the cost of crude and are not profitable.
The most common spread is the simple 1:1 crack spread. Using the example Pete uses it could be:
- 1 RBOB (Gasoline Future) : 1 Crude Oil Future
- 1 ULSD (Diesel Future) : 1 Crude Oil Future
When a crack spread is positive, meaning that the refined product future is trading more expensive that the crude future, then the refinery is making money. If a crack spread is negative, that means that the refined product future is trading cheaper than the crude price and the refinery is losing money.
Crude oil and the products refined from crude oil have different pricing mechanics. Crude oil is calculated using dollars/barrel, while the refined products are dollars/gallon.
Because of the difference in the way that the crack spread futures products are priced, it is important that you know how to convert barrels to gallons and vice versa (gallons to barrels).
To convert, we need to gather a little information.
We know that there are 42 gallons in a barrel of oil. Therefore, we can take the price of the refined products and multiply it by 42 to get the equivalent quantity and price for refined products.
To convert RBOB (/RB) from gallons to barrels, the math would look like:
$2.07 (the RBOB Quote Value) x 42 (gallons) = $87.11/barrel.
Once you convert the price per gallon to price per barrel, you must then subtract the quote price of WTI Crude (/CL) from the converted price per barrel. The math would be:
$87.11 - $59.95 = $27.16
$27.16 would be the value of the crack spread (which if you remember, represents the margin that the refineries are making).
If you think that the refinery margin will decrease during the period of time you plan to invest in the crack spread, then you want to sell the refined products contract and buy the crude contract. If you think the margin is going to increase, then you want to sell the crude and buy the refined product contract.
Strategies: Simple 1:1 Crack Spread
Products Discussed In This Episode: /CL, /HO, & /RB