Crack Spread
The word "spread" is generally used in the financial industry to
refer to the difference between two related entities that can be expressed
quantitatively while the word "crack" is used in the oil refining
industry as a verb describing the process of separating and transforming the
various chemical components of crude oil into saleable refined products.
Thus the term "crack spread" refers to the spread, or margin, that
a refinery can earn by cracking a barrel of oil into refined products. One
of the most important factors affecting this spread is the relative proportions
of the products produced by a refinery. There is a wide range of such products
which can include gasoline, kerosene, diesel, heating oil, aviation fuel,
asphalt and various others. The mix of refined products is also affected by
the blend of crude oil feedstock processed by a refinery and by the capabilities
of the refinery. Heavier crude oils contain a higher proportion of heavy hydrocarbons
composed of longer carbon chains.
Given a target optimal product mix, an independent oil refiner can attempt
to hedge itself against adverse price movements by buying oil futures and
selling futures for its primary refined products according to the proportions
of its optimal mix.
For simplicity, most refiners wishing to hedge their price exposures have
used a crack ratio usually expressed as X:Y:Z where X represents a number
of barrels of crude oil, Y represents a number of barrels of gasoline and
Z represents a number of barrels of distillate fuel oil, subject to the constraint
that X=Y+Z. This crack ratio is used for hedging purposes by buying X barrels
of crude oil and selling Y barrels of gasoline and Z barrels of distillate
in the futures market. The crack spread X:Y:Z reflects the spread obtaining
by trading oil, gasoline and distillate according to this ratio. Widely used
crack spreads have included 3:2:1, 5:3:2 and 2:1:1.
As the 3:2:1 crack spread is the most popular of these, widely quoted crack
spread benchmarks are the "Gulf Coast 3:2:1" and the "Chicago
3:2:1". Various financial intermediaries in the commodities markets have
tailored their products to facilitate trading crack spreads. For example,
NYMEX offers virtual crack spread futures contracts by treating a basket of
underlying NYMEX futures contracts corresponding to a crack spread as a single
transaction.
Treating crack spread futures baskets as a single transaction has the advantage
of reducing the margin requirements for a crack spread futures position. Other
market participants dealing over the counter provide even more customized
products.
Spread trades
Spread positions offer another way of using futures.There are many types of spreads, but they all have two things in common. First, a spread always involves at least two futures positions, which are maintained simultaneously. For example, a trader may be long 10 June NYMEX contracts and short 10 September NYMEX contracts.
