Spread trades
Second, the price changes in the two or more legs of the position are expected
to have a reasonably predictable relationship and the potential profitability
of the spread lies in that relationship or expected changes to that relationship.
For example, the trader who is long 10 June contracts (the near-term contract)
and short 10 September contracts (the distant contract) will benefit if market
forces cause the near-term contract to make a larger advance than the more
distant contract - or if market forces cause the distant contract to drop
more sharply than the near-term contract.
Crack Spreads contract
NYMEX launched the crack spread contract in 1994. NYMEX treats crack spread
purchases or sales of multiple futures as a single trade for the purposes
of establishing margin requirements. The crack spread contract helps refiners
to lock in a crude oil price and heating oil and unleaded gasoline prices
simultaneously in order to establish a fixed refining margin. A petroleum
refiner, like most manufacturers, is caught between two markets: the raw materials
he has to purchase and the finished products he offers for sale. It is the
nature of these markets for prices to be independently subject to variables
of supply, demand, transportation, and other factors. This can put refiners
at enormous risk when crude oil prices rise while refined product prices stay
static or even decline, thus narrowing the spread. The Exchange facilitates
crack spread trading in its futures trading rings by treating them as a single
transaction for the purpose of determining a market participant's margin requirement.
To calculate the theoretical refining margin, first calculate the combined
value of gasoline and heating oil, and then compare the combined value to
the price of crude.
Since crude oil is quoted in dollars per barrel and the products are quoted
in cents per gallon, heating oil and gasoline prices must be converted to
dollars per barrel by multiplying the cents per gallon price by 42 (there
are 42 gallons in a barrel).
If the combined value of the products is higher than the price of the crude,
the gross cracking margin is positive. Conversely, if the combined value of
the products is less than that of crude, then the cracking margin is negative.
Using a ratio of two crude to one gasoline plus one heating oil, the gross
cracking margin is calculated as follows:
• (Assume heating oil is $2.00 per gallon, gasoline is $2.20 per gallon
and crude is $75.00 per barrel.)
• $2.00 per gallon x 42 = $84 per barrel of heating oil
• $ 2.20 per gallon x 42 = $92.4 per barrel of gasoline
• The sum of the products is: $176.4
• Two barrels of crude ($75 x 2) = $150.00
• Therefore, $176.4- $150.00 = $26.4
• $26.4/2 = $13.2 (margin)
A refiner expects crude prices to hold steady, or rise somewhat, while products
will fall. In this case, the refiner would "sell the crack"; that
is, he would buy crude futures and sell gasoline and heating oil futures.
Conversely, buying the crack means buying gasoline and heating oil and selling
crude.
Whether a hedger is selling the crack or buying the crack reflects what is
done on the product side of the spread.
