Once the hedge is in place, the refiner need not worry about movements in absolute futures prices. He need be concerned only with how the combined value of products moves in relation to the price of crude.
Crack Spread options
Crack spread options are designed to protect the refining margin, while at
the same time allowing refiners and other market participants to take advantage
of favourable changes in the spread, the only cost being that of the upfront
premium.
Hedging crack spreads with future locks a market participant into a differential
which may require him to relinquish a favourable market move in return for
price stability. In other words crack spread options complement the futures
by allowing the refiners to hedge its operating margin at a known up - front
cost while simultaneously allowing it to participate in any future widening
of refining margins. The options give added flexibility to those trying to
manage their risk in increasingly fickle physical market.
Crack spreads are designed to protect the refining margins, or differential,
of gasoline or heating oil to crude oil, not the absolute level of prices.
While crude- to- product ratios of future crack spreads are tailored by traders
to best fit their needs, Crack spread options contracts are standardized exchange
instruments which reflect one to one ratio.
Benefits:
Refiners, Blenders, and marketers have a flexible hedge against variable refining
margins in heating oil and gasoline.
Puts give refiners an instrument for locking in crude cost and product margins
without penalty to further market gains. Calls afford product marketers protection
during unstable spread increases. Crack spread options in general furnish
traders with an efficient mechanism for hedging the changing relationship
between crude and products. They allow refiners to generate income by writing
options. Refiner’s margin could be hedged by utilizing the appropriate
future contracts, but maintaining the hedge essentially locks him into a predetermined
margin.
Options give him the right, but not the obligation, to obtain that margin.
Calendar Spread Options
NYMEX offers calendar spread options on crude oil, heating oil, and unleaded
gasoline Buying a call on the calendar spread options contract will represent
a long position (purchase) in the prompt months of the futures contract and
a short position (sale) in the further months of the contract.
Thus, the storage facility can buy a call on a calendar spread that will allow
it to lock in a storage profit or to arbitrage a spread that is larger than
its cost of Storage.
Storage facilities play an important role in the crude oil and refining supply
chain. Facilities near producing fields allow the producers to store crude
oil temporarily until it is transported to market. Facilities at or near refining
sites allow refiners to store crude oil and refined products. Heating oil
dealers build inventories during the summer and fall for winter delivery.
